Using MSP Business Metrics
Using KPIs/OKRs in your MSP business
Having an objective measurement of how your MSP is performing is important for any business. Having key performance indicators (KPIs), Objectives and Key Results (OKRs), or other metrics-based management tools is important to give you this data.
Using key metrics is important because it can help you judge how you’re doing. Your gut feeling about your business performance is also important, but not a reliable way to measure how your business is performing.
Key metrics can tell you how you’re doing compared to industry peers.
Key metrics can also tell you how you’re doing based on your past performance. This allows you to measure your progress towards your goals.
The industry benchmarks can give you a sense of what’s possible and where you sit in the spectrum of operators in your industry. One word of caution when comparing to industry benchmark metrics. You can’t set industry benchmarks as your goal without knowing where you’re starting from. Benchmarks are interesting and useful for context, but if you are far from the best in class on certain metrics, don’t be tempted to shoot for the stars and hit best-in-class industry targets without some steps in between.
Setting achievable targets first will help create momentum that will create further energy to achieve more. Setting targets and repeatedly failing to achieve them will create a pessimism about the process that will limit your growth.
Internal benchmarking can help give you feedback on if what you’re doing is having a positive impact on your performance. Not measuring your outputs leaves you without any verifiable data on how the changes impact your performance. In this blog, I will detail a few high-level metrics that are useful to monitor your overall business performance.
MSP Business Metrics to Track
If you are a Managed Service Provider (MSP) then the bulk of your revenue is providing technical support and consulting services. This also means that the bulk of your costs will be on staff and systems related to delivering those technical services. Cost management is therefore an extremely important area to monitor.
Gross Margin on Service Delivery
The first metric that should be focused on is the gross margin produced from your service division.
Now a small catch here is that many businesses don’t properly load their cost of goods sold (COGS) into their service division and instead all of the salary costs are further down in the P/L with the rest of the business overhead or sales and general administration (SG&A). So if you don’t have your COGS aligned with your revenue, work with your accountant to re-work your general ledger to align the service delivery costs with the revenue. This is typically tech staff salary and support tools. It does NOT include things like benefits, rent, office equipment, and other administrative business costs.
This metric can vary wildly between businesses, but you should be aiming for 40 to 70% gross margin on service delivery. 50 to 60 percent is a pretty reasonable goal for most businesses. If that seems intimidating don’t stress about how that compares to where you’re at, just set that as your guide and get to work understanding why you may be underperforming and create an action plan to fix any issues that are negatively impacting your gross margins. In most cases, MSPs that have low margins are pricing too low. Never be afraid to go upmarket. The scrappy deals that you managed to win early on in your business, may not serve you anymore. Work on a plan to target and win larger clients using a more industry-aligned pricing strategy. Typical per-seat pricing for all-you-can-eat (AYCE) MSP model is $125-150/seat. For more information on pricing strategy check out another blog post of mine, the “best MSP pricing model.”
Earnings Before Taxes, Depreciation, and Amortization (EBITDA)
EBITDA is a fantastic metric to measure the true profitability of your company. It essentially shows how much free cash flow your business is generating.
Granted there are some drawbacks to using EBITDA for financial analysis, but it’s a very common metric for calculating business health in the MSP channel. Just don’t rely on it alone as a sole indicator of success or profitability. There are plenty of ways to manipulate EBIDTA. Interest payments and depreciation schedules can be altered to make EBITDA represent the cash flow situation better than reality.
Luckily MSP channel businesses typically carry lower depreciable equipment costs, especially now with the move to cloud-based delivery, and often are taking on large loans.
Another consideration around using EBITDA as a comparative metric is that some companies may choose to invest more profit back into the business through training and development opportunities. This type of spending can be a subjective value to the business. There’s no doubt that investing in your staff is a good thing, but it could influence comparing two businesses side by side. One has engaged motivated and happier employees because they are looked after. The other has higher profit margins, but less satisfied staff.
Another consideration when looking at EBITDA as a comparative metric is to use adjusted EBITDA numbers and include the owner’s salary. In many cases, owners pay themselves dividends and their compensation may not be reflected in the EBITDA calculations. This can sweeten the EBITDA numbers, but it’s unrealistic from a valuation standpoint since it’s omitting a large cost to the business.
Client Churn
Client churn is murder on your business. Client churn is often an excellent indicator that your service delivery is failing. It’s very difficult to grow your business 10-20% annually if you’re bleeding 10-20% of your clients at the same time. You should be targeting less than 5% churn on clients annually. You can choose to exclude clients that you fired or were lost due to being acquired or going out of business. This number should reflect the clients that you are losing due to them choosing to use a new provider.
Employee Churn
Employee churn is a very similar issue to client churn. You should be targeting under 5% churn on your staff, but depending on your local market conditions you could see as a high a 10%. Skilled tech talent is in very high demand. People often won’t quit simply for more money, but if they are unhappy it won’t take much to draw them away from your company. Also, even the most loyal employee won’t turn down an insanely good offer.
I’ve encouraged staff in the past to take an offer they came to me with. I didn’t want to lose them but knew there was no way I could justify giving them a 30-40% increase in salary and/or a significant promotion. I want people to be successful, even if that means they can’t be successful here.
If you can’t keep employees you have a problem. Employee churn makes it very difficult to build a high-performing team. You’ll be spending a huge amount of time on training new employees, which is also expensive. You can assume that replacing a staff member will cost you 80-120% of that person’s annual salary. For example, a technical support staff team member making $65,000/yr will cost $52,000 - $78,000 to replace. This is a mix of hard costs and soft costs, but still an unnecessary expense.
There is also a cultural impact to losing staff. If people are quitting you may want to take an honest look at your company culture. I don’t mean the perks you provide your staff. What is the culture of the team? Do they like each other? Are they focused on achieving things or just doing enough to not get in trouble? Do they feel supported? Do they understand what they are trying to achieve and how it will benefit them in their career? People quit managers, not companies.
If you’d like some help upping your game as a manager of a team in an MSP, you’ll love the MSP Service Manager course I built for owners and managers of MSPs.
Yr over Yr Growth
There is an expression that says, “If you’re not growing, you’re dying!” I personally feel this statement a little too much into the hustle culture. There is nothing wrong with a well-run business that doesn’t grow leaps and bounds. Sometimes remaining smaller is simpler and less stressful. You probably won’t be rich, but you could be very happy.
Now that said if you run a business, complemency can be dangerous. You should dedicate some effort to the growth of your business, even if not to grow, but to protect you from some natural client attrition.
You should be looking for 5-20% annual growth. Anything over 20 can get a little rocky and you’ll need very strong fundamentals in place to make this work.
Also, many owners naturally look to mergers and acquisitions (M&A) for growth. This is a common strategy in the industry, but it comes with a TON of risks. M&A as a growth strategy isn’t for everyone. It takes much longer than most people think. Successful M&A campaigns take years, not weeks. Also, the cultural and business disruption of the integration of two companies can be extremely traumatic. If you’re going to pursue an M&A strategy for growth be extremely patient, look for any reason to say no. Spend time on due diligence and ensure the cultural match between the companies is high.
% of your revenue that is MRR
An important measure of your success as an MSP is how much revenue you generate in monthly recurring revenue (MRR).
The term Managed Service Provider (MSP) gets a bit abused. My definition of an MSP is an IT company that provides IT services to multiple clients on a fixed cost basis, billed monthly. So if you’re a true MSP, the majority of your revenue comes from your MRR contracts. A healthy percentage is 75% of annual revenue from MRR. The other 25% is important because the non-recurring revenue (NRR) ensures that you have a consistent project funnel as well. If you’re not seeing 25% of your revenue from project spending and new equipment, then your clients are probably not keeping up with the necessary upgrades and environmental improvements. If clients are not keeping up with current technologies, it will create risk for their business as well as yours.
This NRR spending is driven by healthy Technology/Quarterly Business Review TBR/QBR practices. Contrary to popular opinion, they don’t need to be done on a quarterly basis. They need to be done at the frequency that makes sense to drive the client technology roadmap forward, facilitate budgeting, and maintain a consultative relationship with the client. Typically the larger the client, the more frequently you will need to meet with them.
Striking a healthy balance of 75/25 split between MRR and NRR ensures your business has the monthly cash flow to cover operating expenses while ensuring additional revenue from projects.
The MRR you produce monthly should be close to or greater than your monthly operating expenses. Since MSP work is fixed fee utility-style billing you can charge the client on the first of the month for the work to be done in that month. There’s technically no real reason to wait until the end of the month to send a bill. This creates an unnecessary lag between your expenses and revenue. If you can get clients to agree to Automated Clearing House/Electronic Funds Transfer (ACH/EFT), then you can get paid on the 1st of the month rather than having an average of 30 - 60 days accounts receivable for collection. ACH/EFT also limits your costs on payments like credit card transaction fees.
Going Forward
Knowing your numbers is important to running a healthy business. Setting goals helps provide you and your staff with direction on what’s important. Using KPIs/OKRs helps keep you on track to hitting those goals. These are just a few of the important numbers that are useful in ensuring your business is profitable and successful.
Shockingly, 25% of the managed IT service businesses out there run at break even or lose money! Having healthy margins, limiting your client/employee churn, growing your MRR, as well as your NRR will help you stay out of the danger zone so many of your peers get trapped in.
