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Digital transformation is coming for every industry, and managed services is no exception. Now more than ever, staying on top of managed services trends is necessary for you to take advantage of its increasing revenue opportunities.
For the past few years, managed services has been one of the fastest growing revenue engines of the technology industry. Managed service’s market growth means that it now makes up a substantial percentage of the total yearly revenue for tech companies. In fact, managed services has been growing at a rate of 20% or more for the past 24 months!
These figures include revenues from both subscription and traditional technology sales tracked through TSIA’s Cloud 40 Index and Technology and Service 50 Index (where we track the quarterly financials of the most influential cloud and technology solution providers). We also included data from our benchmark database for revenue streams, including hardware, software, and services (Professional, Support, Education, Customer Success, etc.).
What is behind the continual increase in managed services revenue? There can be little doubt that COVID-19 has been an accelerator for companies moving to subscription offerings such as cloud and managed services. But this only expedited the wave of digital transformation that was always headed for the heart of the industry.
The digital transformation has changed where and how customers and companies do business. As more and more of our lives involve a digital touchpoint, the market has driven companies to digitize their processes, products, and services. We are seeing a rapid acceleration of digital transformation for every business model across our entire membership community since COVID disruption began.
This is creating the perfect storm for managed services providers. Companies are quickly learning how crucial it is to digitize all processes across the business, and the latest managed services industry trends reflect this. We are seeing a rapid separation of managed service providers (MSP) into two classes we call 1.0 MSPs and 2.0 MSPs.
Looking at the descriptions above, you might find yourself relating more to a 1.0 MSP but wish to prepare your managed service organization for digital transformation. So, what do you need to do to become a 2.0 MSP? By tackling the top challenges facing managed service providers head on and implementing the latest managed service trends in the new year.
The answer to these questions–or not asking them at all–is often where the challenge lies. Let’s take a closer look at the obstacles managed service providers are facing and ways you can overcome them to excel at digital transformation in managed services.
An Encouraging Sign of the Times
The most recent TSIA Managed Services Benchmark Gold Standard shows that the average growth rate for new managed services agreements is 20%. However, as with all average metrics, there is a range of responses that comprise that average.
The data tells us that the growth rates for MSPs have a range of -27% all the way to 115%. The majority of companies in the benchmark database are performing well under the average of 20%. (The median figure for the data set above is 10%.) While 20% average growth rate sounds great, most MSPs are not experiencing that kind of growth. The encouraging news is that they can.
Why Recurring Revenue Keeps You “In Motion”
Managed services is a recurring revenue stream. For executives that have learned the power of recurring revenue (thank you cloud services), they understand that it creates a dependable, predictable revenue model for the company.
Managed services follows Newton’s first law of motion: an object that is in motion will stay in motion if there is no other force acting on that object. The object, in this case, is a managed service agreement. We once had a managed services executive say it like this, “We’ve generated a ton of inertia with our managed services revenue that we’ve built up over the past three years; we just have to not screw it up and it will be unstoppable.”
This is why companies that have made the pivot to recurring revenue streams have substantially higher valuations than those that still focus on product-centric, transactional businesses. In fact, a previous prediction from The World Economic Forum is that “All Products Will Have Become Services” by 2030. If this is true, then shouldn’t the retention of the recurring revenue from services be one of the absolute top priorities for a managed services executive?
The data tells us that the average recurring revenue retention rate for managed services is 90%. Yet again, more than half of the members in the benchmark database have average retention rates below 90% with an overall range of 70% to 100%.
Choosing Operating Income Over Gross Margin
There are two core profitability metrics that are commonly used in the technology industry to understand profitability of revenue: gross margin and operating income.
Gross margin is often the go-to metric for tech execs; you’ll often hear, “what’s the gross margin of this business or that business?” Rarely do you hear the better question, “what is the operating income of the managed services business?” However, between the two, operating income is a far superior metric to understand whether or not a services business is profitable.
From the 140+ managed services organizations that TSIA has benchmarked, no two calculate gross margin in exactly the same way. There is a constant debate over what costs are “above-the-line” or “below-the-line.” Every finance team has their preferred way of calculating gross margin for managed services.
Some companies even have different gross margin calculations for different product and service lines. In other words, you’ll never get a true “apples-to-apples” comparison with your peers in the industry.
Operating income, on the other hand, is simply all revenue minus all direct and indirect costs. With gross margin, you never really know if a business is truly profitable, at a bottom-line level. With operating income, you always know.
Once again, there is no surprise that there is a wide range in performance of operating income across the MSPs in the TSIA benchmark database. The average is at 10%, the lowest operating income is at -17%, and the highest is at an outstanding level of 31%!
While there are dozens upon dozens of challenges facing today’s managed services organizations, we’ve intentionally focused on the three most basic and most important ones. These are the keys for those struggling to become a 2.0 MSP or working tirelessly to stay one. In order to do this, every executive should be laser focused on growing managed service revenue, ensuring profitability, and driving retention.
As managed services continue to grow their portion of overall company revenues, we see leaders across the industry addressing these challenges. They do this through building digitized, standardized, scalable, and repeatable capabilities to drive better performance on all these key metrics.
In our freely available “State of Managed Services 2022” report, we outline three core approaches that leading managed services providers are using to digitize and streamline their businesses. Through these methods, we see them drive improvements in growth, retention, and profitability. If you are underperforming on any of the metrics discussed above or would like to achieve pacesetter status, these trending practices and capabilities can help you improve your performance.
They are building standard services catalogs supported by standardized delivery operations. They’re making substantial investments in a digital delivery platform focused on scaling operations. A third area of focus for the Digital Managed Services Provider is a formal Services R&D budget to invest heavily in next-generation service automation capabilities.
Would you like to know how you compare to your peers and the industry overall in your managed services evolution from a resource intensive classic managed services providers to a software-oriented digital managed services providers? Would you like to learn more about the keys to successfully creating, growing, and scaling a highly profitable managed services business? Reach out to TSIA to learn more!
January 27, 2022
Jeff Connolly is the former vice president of managed services research for TSIA. He is a video and telecommunications industry veteran, with over 20 years of experience in managed services and Cloud delivery models. In his role at TSIA, Jeff provided members with fact-based education and insight into the performance and operations of managed services providers of all sizes.
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The Technology & Services Industry Association (TSIA) is dedicated to helping technology and services organizations large and small grow and advance in the technology industry. Find out how you can achieve success, too. Call us at 800-876-6511 or we can call you.