Data and analytics provide valuable insights into the past, current, and future state of your Managed Services business. Which Managed Services metrics are the most valuable, however, is a matter for debate. At TSIA, we have pinpointed the eight Managed Service provider metrics that will provide the most complete picture of the financial health of your Managed Services organization.
The Importance of Measuring the Right Managed Services KPIs
Data and analytics serve as barometers for all businesses. You are almost certainly using some metrics to assess company performance. There are, however, distinctions that set key MSP metrics apart from all other data concerning your company.
The key performance indicators are the metrics that align most closely with your organization’s specific goals. These goals should be rooted in your organization’s overall strategy. Therefore, the KPIs are essentially measuring your progress toward achieving your strategic goals. In that sense, the KPIs are vital for the long-term success of the company.
To think of it another way, key performance indicators are also essential for your company’s continual improvement. By constantly tracking your progress toward strategic goals, you will be better able to course correct quickly and effectively.
Without further ado, here are the managed services metrics that all providers should be measuring:
Growth Metrics
1 - Total Recurring Revenue Growth Rate
It shouldn’t come as any surprise that revenue is one of the most important Managed Service provider metrics. There are, however, numerous ways to examine revenue contribution. Which one is best?
TSIA advocates for total recurring revenue growth, since it focuses on the core engine of your business – subscription-based recurring revenue and excludes one-time, transactional revenues that are often unpredictable. Total recurring revenue growth takes into account all recurring revenue from the previous year as well as newly contracted recurring Managed Services revenue.
To calculate your total recurring revenue growth rate, take the current year’s recurring Managed Services revenue and subtract the previous year’s total recurring Managed Services revenue. Divide the difference by the previous year’s total recurring Managed Services revenue and convert into a percentage.
2 - Top-Line (Net-New) Recurring Revenue Growth Rate
In contrast to the total recurring revenue growth, the top-line recurring revenue growth focuses exclusively on new recurring revenue that was signed in a given year. Top-line recurring revenue growth is valuable because it indicates the market’s current propensity to buy, the effectiveness of your sales team, and the perceived value of your offering.
A low growth rate or a major negative fluctuation in top-line recurring revenue growth year-over-year is a major red flag. Such a trend indicates a significant problem that you need to address, such as inadequate sales skills or inadequate offers in the market.
To calculate top-line recurring revenue growth, take the most current full year new recurring revenue and subtract the previous year’s new recurring revenue. Divide the difference by the previous year’s net-new recurring revenue and convert into a percentage.
3 - TCV Bookings Growth Rate
While the two previous Managed Services KPIs looked at revenue on an annual basis, some Managed Services contracts are signed for multi-year terms. To capture these longer-term commitments, your total contract value (TCV) bookings rate is a useful metric.
The TCV bookings rate takes into account the full span of the contract. Thus, if a customer signs a two-year contract for a subscription that costs $10,000 per month, the TCV would be $240,000. By monitoring the TCV bookings rate, you get a better sense of the market demand for your Managed Services.
To calculate, take the total value of existing contracts and subtract the total value of the previous year’s contracts. Divide the difference by the previous year’s total contract value. Convert into a percentage.
4 - Base Revenue Growth Rate
The base revenue growth rate is a valued metric because it focuses exclusively on your existing core group of Managed Services customers. The base customers represent your most loyal customers.
At least, the base customers should be your most loyal customers. If the base revenue growth rate is slowing or declining, you probably have a problem – your most loyal customers may not be valuing your services the way they once did.
To calculate the base revenue growth rate, take the revenue from existing customers for the most current full year (excluding revenue from new customers). Subtract the previous year’s base revenue. Divide the difference by the previous year’s base revenue and convert into a percentage.
Profitability Metrics
5 - Gross Margin
Gross margin is often used as the metric to gauge profitability in the tech industry, but it may not be the best metric to evaluate the profitability of a Managed Services organization. Gross margin is a simple calculation of subtracting direct costs from revenue, but there are many factors that go into the cost of Managed Services (operating expenses, allocated costs, overhead, etc.). As a result, there is not consensus on how Managed Services organizations should calculate gross margin (i.e., there are varying interpretations of what are considered “direct” versus “indirect” costs across organizations).
So then why is gross margin included on this list of Managed Services KPIs? Since gross margin is recognized as a meaningful metric in the tech industry, Managed Services leaders will almost certainly be asked about it. You will need to be able to answer questions about the gross margin of Managed Services.
As mentioned, TSIA has not seen clear agreement on how Managed Services organizations should calculate gross margin. Nevertheless, we recommend keeping it simple: services revenue minus direct delivery expenses and direct technology expenses. Direct delivery expenses include direct FTE (full-time equivalent – employees and contractors) delivery expenses, such as employee base salary, incentives, and benefits. Direct technology expenses include service delivery infrastructure (tools/platforms), and also any embedded products or technologies (for OpEx deals), etc. To calculate, subtract all direct costs from the total Managed Service revenue. Divide that number by the total Managed Services revenue and convert into a percentage.
6 - Net Operating Income
When it comes to assessing the profitability of a Managed Services organization, net operating income is a more accurate gauge than gross margin because this “bottom line” metric accounts for all direct and indirect expenses. Net operating income takes into account the reality that Managed Services are heavily supported by indirect operating expenses, like Sales, General and Administrative (G&A), Research and Development (R&D), and Depreciation and Amortizations expenses.
To calculate your net operating income, subtract all direct and indirect expenses from your total Managed Services revenue. Divide that number by the total Managed Services revenue and convert into a percentage.
Retention Metrics
7 - Managed Service Recurring Revenue Retention Rate
To underscore the importance of focusing on recurring revenue as a key MSP metric, we also recommend including recurring revenue retention rate as a top revenue metric to monitor. The Managed Service recurring revenue retention rate is simply the amount of recurring revenue from the previous year that you were able to carry forward into the current year.
To calculate the Managed Services recurring revenue retention rate, take the total Managed Services recurring revenue for the current year (minus any new recurring Managed Services revenue from the current year). Subtract the total recurring Managed Services revenue from the previous year. Divide this number by the previous year’s total recurring Managed Services revenue and convert into a percentage.
8 - Managed Service Contract Renewal Rate
We all know that it is generally cheaper and more efficient to retain current customers than it is to land a new contract. Therefore, every Managed Services organization needs to also pay attention to its contract renewal rate.
To calculate your renewal rate, divide the number of current year Managed Services contract renewals by the total number of contracts that were up for renewal.
You can learn more about how contract renewal rates impact your bottom line by using TSIA’s Renewal Rate ROI Calculator. The calculator is based on TSIA benchmarking that will help you forecast your renewal revenue.
A Final Word on Managed Services Metrics
The KPIs listed above have proven to be predictive gauges for Managed Services organizations. There may be additional metrics that suit your particular business as well. Whatever Managed Services KPIs you choose to follow, make sure to share them with your team. The goal is to have the whole Managed Services organization working toward improving these KPIs.
Contact TSIA if you need to discuss how to select or measure your Managed Services KPIs. Also, TSIA members can always find more information about Managed Services metrics, including current metrics for many of the KPIs above, in our annual State of Managed Services research report.