Six Financial Tips for Managed Services Providers From Two Pros
How can MSPs and IT service providers better manage their finances, motivate their sales teams and maximize their profits? Coreconnex‘s Frank Coker and Service Leadership Inc.‘s Paul Dippell provided some eye-opening answers during the Tigerpaw User Conference in Dallas today. Here are their top six financial tips. I don’t often say this but this particular blog entry is one that you should print and re-read a few times. Take a look.
When starting the session, Dippell said top-performing MSPs make 3.4 times as much profit vs. the typical managed services provider. So, how do the top MSPs outperform average MSPs? Dippell and Coker offered six tips:
1. The only formula that matters: More gross margin with less expenses equals better profits
2. Know your gross margins: Here are some ways to think about gross margins, noted Coker:
- Product: Price determined by market MINUS the cost determined by vendor
- Time and Materials: More hours X rate per hour MINUS cost per hour
- Flat Fee: Less hours X rate per hour MINUS cost per hour
Continuing that gross margin point, Coker and Dippell said you have to have a relationship between billing and relationships:
- You should be able to take your billable service revenue, divide it by service wages (payroll) and the minimum result should be a 2.5 multiple. A lot of service providers are at 1.9 or 2.0, and they’re at break-even as a business, says Dippell. Also, don’t include cloud services in the formula since it’s not part of your billable service revenue.
- For example, you should be generating $125,000 in service revenue per month, divide it by $50,000 in payroll, and the minimum should be 2.5. But here’s the twist. Once you add back in benefits, taxes, training and service management, you’re at 50% loaded margin. But if you spend 35% in sales, marketing, general and administration costs, your net profit is 15%, which is best in class.
3. Use incentive compensation that works:
- Win-Win: Rewards behaviors which attain company goals.
- Affordable: If everyone hits their goals, can I afford to pay it?
- Manageable: Not burdensome to calculate
- Purposeful: Attracts eagles (the real go-getters) and repels turkeys (scares away potentially bad hires before they even want to take the position).
- Other tips: It has to be fair, understandable, measurable, attainable, and over-attainable — if a salesperson outperforms the goal, they should earn even more faster.
Some ratios to consider, from Dippell and Coker.
- Sales people should be paid no more than 20 percent of the gross margin money they generate, with 40% base and 60% commission.
- On the service team, you can only afford to pay up to 2.5 times the service revenue they generate, with an 80% base and 20% incentive.
4. Use a chart of accounts that works: Coker says the chart of accounts needs to give you visibility into lines of business. A good solutions provider chart of accounts includes subdivisions. A sample, effective chart of accounts that works can include:
- Product Revenue
- Service A Revenue
- Service B Revenue
- Total Revenue
- Product COGS
- Service A COGS (Payroll)
- Service B COGS (Payroll)
- Total COG
- Product GM
- Service A GM
- Service B GM
- Total GM
- Sales and marketing expense
- Other expenses
- total expenses
- Profit
5. Known your predominant business model: Compare your performance to only those who are in your predominantly similar business model. Franks tool determines it based on your input. There are roughly 10 different PBMs, ranging from product-centric resellers to managed services. Check in with Coker and Dippell for the entire list and the utilization patterns. Also, Coker and Dippell provided an eye-opening look at how the financial models vary from product-centric resellers to MSPs. Sorry I didn’t capture everything here…
6. Qualify, Qualify, Qualify: Qualify your customers BEFORE you do a scope of work or proposal. Bottom performing teams win one-third of proposals; top performing teams win two-thirds of the time. So, how do you increase your odds of winning? Dippell says:
- If you have given the decision maker a ballpark price and they want to keep talking, you can forecast the win at 80% likely to close at 80% of the ballpart price … and you can write a statement of work.
- If you have given the decision maker a ballpark price and they haven’t indicated interest in more talk, then don’t write a scope of work.
Bonus: There’s a seventh tip. But since I’ve already lifted the first six tips from Dippell and Coker, I’m going to stop writing now and encourage you to instead reach out to Dippell and Coker. You can find them on twitter at @pdippell and @coreconnex.
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Thanks Joe! This is great information.
Jeff: Don’t thank me. Thank Frank Coker and Paul Dippell for a pure financial presentation and zero sales pitch. VARs and MSPs in the audience were taking notes frantically…
-jp
Outstanding Information. I know we are constantly asked about point 2 and 4 all the time when people are asking us about how efficiently we run our business. The GM ratios they mention are also very accurate from what I have seen from other MSP’s.
Troy: Item 4 (chart of accounts) was completely new territory for me since my business partner handles our finances. Fortunately, she already leverages a chart of accounts approach that is similar to what Dippell and Cocker recommended. (Translation: It pays to have a good business partner.)
Joe, great job capturing the critical points! Your blog is one of my routine “must reads!”
One important correction: The last bullet under item 3 above (compensation) is reversed. It should say you can’t afford to pay the service team more than the revenue they generate divided by 2.5.
Companies that consistently hit the 6 targets listed above are very rewarding for their owners and top managers. Let me know if you want any scoop about tip # 7. It’s all about monitoring and managing your business trend lines. This will change the way you see your business.
Cheers!!
Frank: Leave it to a blogger to screw up the facts. Sorry about that. I will make the correction. Thanks so much for your time and expertise at the conference.
-jp
incentive is the best way for business, but it is also the hardest to apply. You need to make sure the goal for everyone is same. but sometime the incentive is just too less to motivate people.
Grand Group: Should goal for everyone really be the same? Bigger companies like Microsoft are famed for setting up competing groups that may have slightly different goals, creating competition within the organization. Not always fun, but sometimes effective…
-jp
Found this via a search — now dated, but still useful info — thank you. Regarding the recommendation of “Sales people should be paid no more than 20 percent of the gross margin money they generate,” is that for dedicated new business development reps? What should that ratio be for account managers?
Beth,
Sorry for my belated reply. I will ping Frank Coker and Paul Dippell to see if they have any updated thoughts on this. Stay tuned.
-jp