I’ve been thinking a lot about profitability in solution provider businesses lately, particularly as it relates to Managed Services Providers. The questions of “why are some more profitable than others” and “how do others achieve that profitability” are two of the main ones.
Efficiency and profitability
For MSPs, there is a close correlation between efficiency and profitability. Put simply, this means that the more efficient that an MSP becomes, the more likely they are to be more profitable. Since I’m a big fan of profit in a business, this naturally seems like a good thing. In general, there is a very simple formula for determining profit. Take your revenue, and then subtract your cost of delivering the service, or “Cost of Goods Sold” (COGS). This results in your gross profit. Then, subtract out the costs of your overhead, or the SG&A costs. This results in your net profit. Pretty simple. To change the results of your formula, you can generally pull on one of three levers. You can add more money to the top by boosting revenue, or you can change the cost of delivering the service, or you can change the overall cost of your business in overhead.
Of course, it’s not that simple in practical terms. “Selling more” – or driving more to revenue – will generally force an increase in your cost of delivering the service. Cutting your cost of delivering the service – letting people go, for instance – may have the short term effect of driving profits, but if the service degrades and customers leave, you will have a problem on your hands in the long term. Understanding the consequences of these decisions is how building your business happens.
Why efficiency matters
Using technology to deliver your managed service rather than people is more efficient, as well as cheaper and more scalable. People are an expensive resource in your service delivery – generally making up the vast majority of your COGS – where your toolset is generally far less. The more work you can have your tools perform for you, the more you can drive profit in your business. Linked to this is the idea that less tools are more efficient. The more simple your systems are, the easier it is to use them, maintain them, and train your people on them.
This is further seen in the toolset you manage. The more you can simplify your end user’s environment, the easier it is for you to manage. Think about backup for a moment. Having multiple backup systems across your customer sites requires you to monitor and manage multiple systems, meaning your RMM has to be setup for that management. Additionally, your own technicians have to be cross trained on all the different backup systems that your customers are using. The more vendors you have to support, the greater the complexity.
Reducing the number of systems you have to manage results in more efficiency, and in general more profit. This is why integration matters – reducing the number of steps to manage a backup system, for example, means individual engineers can support more customers. This keeps your COGS level as revenue grows, and allows your business to be more profitable with growth.
Understanding the ways these levers all work is the key to running a successful MSP. Start with the simple formula, and you can start to understand how these factors all interrelate.