Transitioning from Break-Fix to Managed Services: Step 1 — Financial Planning

In part 1 of our series on transitioning from break-fix to managed services, we discuss the financial challenges you'll face, including cash flow, KPIs, initial investments, and more.

Like so many IT solution providers who start out making money fixing broken computers and other IT gear (i.e. break-fix companies), eventually there’s an epiphany where you realize the inherent flaws of this business model:

  • When your customers call they’re stressed out and each minute it takes to fix their problem (as quickly and cheaply as possible) represents a growing financial loss.
  • It’s impossible to predict when the next IT emergency is going to arise, which means sometimes your technicians are standing around with nothing to do and other times you’re understaffed and need to pay overtime.
  • If you offer prepaid blocks of labor hours, most clients treat it like gold and hoard it. If a client does use a portion of their time block, you receive complaints that the hours they’re charged are greater than the time your tech spent at their facility.

Many of these same break-fix companies would concede that building a stable managed services practice — with steady revenue, positive and consultative customer engagements and higher business valuations — is the smarter option. But, transitioning from A to B isn’t intuitive, nor is it easy.

Fortunately, you’ve come to the right place. XaaS (“Everything as a Service”) Journal was started with the specific goal of helping IT solution providers (i.e. the channel) make this very important business transformation.

Without further ado, let’s dig into the five key steps to transitioning from break-fix to managed services, which includes:

  1. Developing a financial plan
  2. Determining which services to sell
  3. Creating an operational plan
  4. Marketing your services
  5. Training your salespeople

To start, let’s focus on the financial plan and choosing a service, and we’ll cover the remaining steps in subsequent articles.

$10,000 vs. $500-per-Month

The title of this section illustrates one of the biggest obstacles companies face when they decide to sell managed services: They’re moving away from big upgrade and break-fix projects (i.e., the $10,000 sale) and replacing it with contracts that may start out at just a few hundred dollars a month. Sure, this will likely lead to fewer objections early on in the sales process, but it can also wreck your business if you’re not careful.

Here’s another way to look at it. Determine your average number of sales and the average amount of each sale made over the previous 12 months. For argument’s sake, let’s say that you averaged five sales a month with an average value of $10,000 per sale — so you’re averaging $50,000 a month. Now consider how it would look if one of those monthly sales was a managed services sale that generated $500 a month. What does that mean? Instead of bringing in $50,000 that month, you’re earning $40,500 which is $9,500 less than you’re used to making.

Your financial plan needs to address how you’re going to accommodate this temporary drop in sales. One option may be to hire another salesperson dedicated only to selling managed services. Or, you may need to put additional restrictions on how many managed services accounts you can take on per month, per quarter or per year.

Another point to keep in mind with your financial plan is that you don’t have to go all-in right away with managed services; it’s possible to take a phased approach. Many successful MSPs take a “land and expand” approach where they get their foot in the door with one or two basic managed services (typically backup and disaster recovery or security) and they add additional services over time.

One final thought is that there are opportunities to bundle professional services (often paid upfront) with managed services, which also can help reduce the delta between the two sales models. For example, consider a customer migrating from a legacy on-premise email solution to Microsoft Office 365. Someone has to migrate the old data and set up the mailboxes — these are professional services that can be attached to the cloud solutions and billed upfront. Perhaps the client would benefit from a helpdesk to answer user questions, or an administrator to manage the directory — these are managed services that enhance client value and add recurring monthly revenue. Make these add-on services part of the planning process to capture the full opportunity and make these complementary services part of your sales and marketing plan.

A Simple Litmus Test for Adding New Services

When it comes to selling managed services, keep in mind that you’re not selling a new kind of solution (in most cases); you’re selling a different consumption model. Before shifting any solution to a managed services, make sure it doesn’t damage your overall profitability due to the deferred revenue and profit of a subscription model.

To do this, review your current technology practices at the solution level and ask the following questions:

  1. What profit margins do you currently see in this solution?
  2. How fast is this business growing?
  3. What is your win rate on sales proposals for this solution?
  4. Are you seeing demand for a subscription version of this solution?

The answers to these questions will place the solution into one of two categories:

  1. Don’t Change a Good Thing. If the current sales model is driving high margins, growing fast, has a high win rate, and there has been little customer demand for something different, it makes sense to stay the course and keep doing what you’re doing. This also indicates that if you want to sell managed services, you’re going to need to find new clients. In some cases, it can also indicate that you’re already providing the value of a managed services offering (e.g., remote monitoring, patch management) – and probably for free, which is going to make in nearly impossible to get clients to start paying for it.
  2. Switch to an as-a-Service Offering. If the current solution provides a low profit margin, revenue isn’t growing, or it’s creating long sales cycles due to low win rates, and customers are asking about other options, it’s time to seriously consider making the switch to an as-a-service solution.
Let KPIs Guide Your Business Decisions

Developing a bottoms-up financial plan based on actionable KPI’s (key performance indicators) is a vital prerequisite to becoming a successful MSP. Five KPIs that should be top of mind include:

  • Gross Margin—provides a high-level view of your total profitability. To calculate this KPI, use the following formula: Gross margin = (revenue – cost of goods sold) / revenue.
  • Contribution Margin—offers a more granular view of profitability beyond gross margin by focusing on a single product or service. Use the following formula: Contribution margin = (revenue from product or service – COGS for product or service) / revenue from product or service)
  • Customer Acquisition Cost—this KPI is often used in conjunction with specific marketing campaigns for a specific period. For example, if 20 prospects were invited to a lunch and learn and the total cost of food, labor, collateral and messaging was $5,000 and 5 prospects were converted to customers within a designated period (e.g., 90 days), the CAC of that initiative is $1,000 per customer. Customer acquisition cost = Expenses associated with acquiring customers / Number of customers acquired.
  • Life Time Value (LTV) of Customers—this KPI shows the MSP the total profit expected from a customer throughout their time as a customer. The easiest way to calculate LTV is to use the average profit from a customer per month/year and multiply that figure by the average lifetime in months/years of a typical customer. For example, if a customer yields $6,000 of profit per year and the average customer stays a customer for 10 years, then LTV is $60,000.
  • Lifetime Profitability—LTV minus CAC yields the lifetime profitability of a customer as well as the breakeven period for a customer, which tells you how long it takes to make back the money spent to acquire a customer.

There are lots of other useful KPIs to consider as well such as number of marketing leads generated by specific marketing activities, lead conversion rates, win rates, average contract value, and gross margin just to name a few. Each as-a-service offering should have its own monthly financial plan that can be reviewed regularly to make sure you’re on track to meet your objectives. By tying your financial plan to KPIs, you’ll quickly see where you’re missing the mark and can take appropriate actions to change course.

Don’t Forget To Change Your Sales Compensation Model

When resellers make the decision to start selling managed services but don’t adjust their sales compensation model, what usually happens is that the new service program never gets off the ground. Most salespeople would rather earn a large, one-time commission upfront rather than earning a small commission each month. One proven way to incentivize salespeople to sell subscription-based IT services is to pay them 12 months’ worth of commissions upfront.  You may need to leverage cash flow from your break-fix and professional sales and services, but, you’ll still come out much further ahead in the long run.

Consider The Investments Required To Sell Managed Services

A final financial consideration to keep in mind is the investments needed in vendor partnerships and sales training. With regard to vendor partnerships, it’s important to do your due diligence to ensure potential partners are financially sound and that they have profitable channel programs in place. Joining a peer group or working with a value-added distributor is a good way to reduce the burden of testing every product or service yourself.

Making the time and financial investment in your salespeople is critical to the success of your new managed service offering as well because there are key differences to the sales process they will need to learn. Your vendors and distributor partners play a key role in this process, too.

One other thing that’s critical at this point in the process is that the C-level executives within your company need to be involved and on board each step of the way; otherwise, your well-meaning plans to start selling a new service won’t get off the ground. By following these tips, and resisting the temptation to take shortcuts, you’ll build a better foundation for your business that will help you make the transition into selling managed services — or simply selling additional managed services — much smoother.