Do Managed Services Providers weather economic downturns better than other types of Solution Providers?
Do Managed Services Providers weather economic downturns better than other types of Solution Providers? According to Paul Dippell from Service Leadership, Inc., they do. In his November newsletter, Paul breaks down data culled from his Service Leadership Index™ benchmark report for participating VARs and Service Providers between the years 2002 and a projected 2008 and and reveals the following results:
· Solution Providers with product-centric business models are expecting considerably less profit growth than those with more strongly services-centric business models
· Hardware Resellers are reporting an actual downturn in projected profits for 2008
· For the year 2005, Solution Providers serving the largest customers were the most profitable
· Those same large-customer Solution Providers are least optimistic about 2008, with those Solution Providers serving the 26-100 user segment the most optimistic
· In the three economic downturns of the late 1980's and 1990's, those Solution Providers who were delivering Managed Services to enterprise clients found that these clients outsourced as much or more to them during downturns
So what should we, as Solution Providers do? Paul advises us to be cautious in 2008, and be sure to:
· Include a lower revenue case in budget planning
· Assume it will take longer to collect on oustanding invoices as clients push out payments
· Assume that credit will be more difficult to obtain or expand
· Assume that employees will push towards less incentive risk in their comp plans
· Keep focus on Managed Services, because when revenue is uncertain, flat fee offerings have more appeal, and when profits are uncertain, companies reduce staff and turn to outside service providers - in addition, during recessions, clients hang on to IT equipment longer, driving up the need for maintenance services
For MSP's, Paul suggests the following:
· Create a low-frills, full-service offering
· Include an annual budget increase clause in your Managed Services Agreements (as in the sample Managed Services Agreement included in our book The Guide to a Successful Managed Services Practice)
· Automate your processes and procedures as much as possible, and get your clients to adhere to your technology standards (your "Certified Network" as in our book The Guide to a Successful Managed Services Practice), or pay more for their choice to hurt your economies of scale
· Leverage Managed Services tool vendors who let you "pay as you go", allowing you to conserve cash
· Keep margins and pricing high
· Consider spending more on marketing to bring in leads
· Position your offering as a true cost-savings, budget and HR flexibility solution (use our new client Cost Savings Analysis approach to sell your Managed Services on value and cost savings, as in our book The Guide to a Successful Managed Services Practice)
I can't agree with Paul more. His data confirms what we have been experiencing in this space with our Partners, and we strongly endorse Paul's Service Leadership Index™ benchmark report. The following is Paul Dippell's November newsletter in it's entirety. I suggest you read it completely, in order to put my comments into perspective for yourself and your business.
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Special Economic Advisory
Recession Planning?
The announcement a week ago by John Chambers, CEO of Cisco, that 2008 may be a rough year in the IT industry, and by Shearson-Lehman this week about the possibility of a U.S. recession probably did not take our Service Leadership Index™ Group members and benchmark report customers by surprise. In August, when we released our latest Service Leadership Index™ benchmark report, we advised our clients to exercise caution when planning for 2008 and beyond. Why? In our report, we stated that, for the first time since 2003, participating Solution Providers reported that they expected a downturn in growth of net profit in the upcoming year. Specifically, we reported, year-over-year change in net profits since 2002 have been as follows: Year Change in Net Profits 2003 Down 8.9% from 2002 2004 Up 24.4% from 2003 2005 Up 43.1% from 2004 2006 Up 39.7% from 2005 2007 Up from 24.4%2006 2008 Down 0.4% from 2007
We reported this several months before the sub-prime credit crunch began to make the news.
Looking at the table above, the astute eye will notice that profit growth has in fact been decelerating since 2005. Although profit growth rates were still healthy in 2006 and even 2007, once we climbed out of the last (IT-led in that case) recession, profits accelerated sharply and have since tapered off.
That leads us to the current cautionary situation.
Digging deeper, here is what our Service Leadership Index™ clients were advised.
To determine which sectors of the Solution Provider industry were most pessimistic about 2008, we analyzed the data by the Solution Provider’s business model and by the size of client being pursued by the Solution Provider.
Pre-Tax Profit Trend by Business Model
The chart below, from the Service Leadership Index™ 2007 Profitability Report, shows that those Solution Providers with product-centric business models are expecting considerably less profit growth than those with more strongly services-centric business models.
The reddish bars and trend lines are the actual profits (for 2005 and 2006) and expectations (for 2007 and 2008) from product-centric Solution Providers. The green bars and lines are the same from the more services-centric ones.
Clearly, the more product-centric Solution Providers are at best only moderately optimistic about 2008. Although they expect 2008 to be better than 2007, it is worse than either 2006 or 2005, so they are reporting being on a downward trend.
The most bullish are the Solution Providers with the 60% to 80% Services business model, and we tend to agree this is often the strongest business model because – while being services focused – it still allows the use of product sales as a wedge into new accounts and a way to encourage lead sourcing from product manufacturers.
But exactly which sorts of services business models are the most and least bullish about 2008?
The chart below shows the profit actual and expectations for Solution Providers who have one of four predominant lines of business:
- Predominantly Managed Services
- Predominantly Project Services
- Predominantly Technical Services
- Predominantly Hardware Resell
Here we can see in detail one source of the pessimism spotted by our profit trend data above: Hardware Resellers are reporting an actual downturn in projected profits for 2008.
Managed Services-centric Solution Providers, in contrast, are the most bullish, projecting a remarkable 23.5% pre-tax in 2008 (having weathered losses in 2005 when they were investing in getting that line of business going and growing).
While this high projected level of profit is indeed sometimes matched by best-in-class Managed Services providers, in general the forward projections are often a few points too optimistic. Even allowing for that buoyant mood, Managed Services providers are clearly expecting to have a good 2008.
A worrisome contradiction in this data is that, while Hardware Resell-predominant Solution Providers are pessimistic, those who are Project Services-predominant are not. Since the sale of project services depends primarily on the acquisition of new product by the customer which then needs to be installed, these are contradictory expectations.
Our guess is that the Hardware Resell companies are likely to be the more accurate of the two about 2008, which means that Project Services firms might want to keep a close eye on customer capital expense budget planning.
In the “What to Do” section at the end of this newsletter, we’ll talk about what steps Solution Providers in each of these business models can take to prepare for a possible economic recession.
Pre-Tax Profit Trend by Customer Size
In addition, in August we also told our Service Leadership Index™ Group customers about the profits expected by customer size. Here again, the details are instructive.
The chart above shows the four year (2005-06 actual, 2007-08 projected) profit trend for Solution Providers grouped by their predominant customer size.
The darkest trend line says that Solution Providers serving the largest customers were most profitable in 2005.
The lightest trend line says that those same large-customer Solution Providers are least optimistic about 2008, and that the Solution Providers serving the 26-100 user segment are the most optimistic, followed by the 500 to 1000 user space and the 1-25 user space.
This is good news for SMB-focused Solution Providers, and cautionary news for those serving larger customers.
That said, unlike the recession of 2001-2004 in which SMB customers largely did not pull back on IT spending, that happy outcome may not be the case in a new recession. Why? Because starting in 2001, a game-changing technology event occurred. While large accounts and Wall Street were busy predicting the demise of the Internet as a new paradigm in business productivity, SMBs were en masse heating up DSL lines, their first full-time connectivity to the cloud, and discovering the Internet as a business tool.
This new full-time connectivity drove – and still drives today – a huge new wave of investment by SMBs in their IT infrastructure.
That said, what was a huge new wave in SMB spending in 2001 through 2003 is now steady growth, not explosive growth, and so a recession today would probably not be offset in the SMB segment by any new wave of spending.
What to Do?
First – as our Service Leadership Index™ customers were advised four months ago – be cautious about your 2008 budgeting. Make sure to:
- Include a lower revenue case in your budget planning
- Assume that your DSO (Days Sales Outstanding, a measure of the days it takes on average for you to collect on your customer invoices) may extend as customers push out payments
- Assume that credit will be harder to obtain or expand
- Assume that employees, perhaps feeling crunched themselves, will push towards less incentive risk (while you will want more) in their comp plans. As their spouses’ jobs potentially become less stable, secure benefits may be a strong desire as well.
Second – keep your focus on Managed Services. We can’t be sure about this in the SMB space yet, because SMB Managed Services hasn’t had to weather a downturn until perhaps now, but in the three economic downturns of the late 1980’s and 1990’s, those Solution Providers who were delivering Managed Services to enterprise customers found that enterprise customers outsourced as much or more to them during downturns.
Why? Because when revenue is uncertain, flat fee offerings have more appeal. When profits are uncertain, companies reduce staff and turn to outside providers.
And lastly but quite important for managed Services providers, when recessions occur, customers hang on to the IT equipment longer, which drives up the need for maintenance services.
If you are providing – or planning to provide – Managed Services here is what we recommend if an economic downturn starts to occur:
- Create a low-frills but still full-service offering. Don’t succumb to the temptation to reduce your flat fee by pushing more of the scope back into “optional” time and materials work. The unexpected T&M charges at the end of the month will upset your customers just when they are trying even harder to manage cash flow.
- Assume that customers will hold onto equipment longer, which will drive up your year/year support costs. Make sure your contracts today have annual budget increase clauses. If they don’t, go back to your existing customers and negotiate them now.
- Your work to document and automate your operational processes will be even more important if you yourself need to downsize or hire lower-cost employees. While it does take investment to build these kinds of efficiency factors, they could make or break your margin flexibility later. And by all means, get your customers to adhere to your technology standards or pay more for their choice to hurt your economies of scale.
- Leverage those Managed Services tool providers who will let you “pay by the sip” to use their licenses or even their behind-the-scenes staffed services. Even though this may cost a little more over time, it will help you conserve your cash for possible rainy days ahead.
- Lastly, the “land grab” for customers continues. Any customer you can sign now is your most secure asset in a downturn. Keep margins and pricing high for now, but consider expending more of it on marketing to bring in leads in the short term. Start to position your offering even more heavily as a true-cost-savings, budget assurance and HR flexibility solution.
If you are a project-centric Solution Provider, we recommend these actions if a downturn starts to occur:
- Obviously, if you are building or can build a Managed Services offering, keep it up, but leverage vendors for pay-as-you-go offerings and business transformation best practices resources to speed the process and reduce your up-front investment requirements.
- Assume that customers’ capital expenditures will drop, resulting in fewer large scale new projects. However, you can position your assessment and re-design services as ways customers can extend the life of their investments by getting the maximum capacity out of them, and then do asset re-allocation projects.
- If your project methodology is solid, and you know and control your project costs, switch to a flat fee pricing methodology. This is more attractive to customers looking to confirm to stricter budgets. It also diverts the discussion from rate per hour, which is always a hot topic in a downturn.
- Pay strict attention to your Multiple of W2 attained by your project teams. Start to stack rank your project people by your most important operating criteria so you know who you can and cannot afford to cut if you need to bring your Multiple of W2 back in line with falling project revenues. A key vulnerability of project-centric firms in downturns is holding on to under-utilized billable people too long. Waiting for a project to close to rescue your billable utilization is a losing game in an environment where capital expense decisions get delayed or cancelled. Take the hard medicine early and fewer will be hurt later on.
For those Solution Providers who are product-resale-centric, here is what we recommend if a downturn starts to occur:
- Investigate expanding your leasing capability. Although credit will be harder to come by, those who can offer lease options to customers will maintain sales volume longer.
- In the last downturn, even SMB-focused product resellers were under pressure, those less so than their mid- and large-market colleagues. Revenue drops of 50% and even 75% were not unusual in the 2001 through 2003 timeframe. Capital expense driven businesses have always suffered heavily during downturns. So re-look at your 2008 budget planning with a stern eye and create an all-hands-on-deck contingency plan.
- If the path to Managed Services looks too long in the face of a downturn, consider partnering with local Managed Services providers to be their equipment, spares and warranty processing resource. To the degree they sell product today, it is their lowest margin offering, and they are likely to have less credit facility than you do; they will want to stop selling product. Conversely, it will be the Managed Services firms that have the closest pulse on their customers’ capital expense plans, and so are the most likely stream of SMB product sales volume.
- Consider getting into the used-equipment market. Margins here are quite strong and in a downturn there will likely be more equipment on the market and more buyers looking for budget-saving ways to get new gear.
Summary and a Year-End Marketing Tip
Obviously, we hope we are wrong about the trends we informed our Service Leadership Index™ customers about in August, and we hope that we can ask for their forgiveness in erring on the side of caution.
But the recent Cisco and Shearson-Lehman guidance underlines the nagging feeling that credit availability is the bellwether of our economy. It’s worth noting that about 30% of Cisco’s own revenue comes from the financial sector, and clearly there are worried financials will be reining back.
As your author writes this, he is on a business and pleasure trip in Europe. In the three months of planning leading up to it, the dollar has dropped in value by a percent or so each month, and the Euro “buy” rate in the hotel lobby downstairs is US$1.55. When a croissant and a cup of coffee works out to be US$18.00…
A marketing tip for your year-end sales push: IRS Section 179 deductions may allow your small business customer to take 100% of the cost of certain capital investments – including computers and software – and deduct it in the current year. We’re not tax professionals, so ask your CPA for the details. But you can use this in a marketing campaign to encourage your customers to make yearend investments. In some cases, the system delivery can be next year.
Service Leadership, Inc. provide total profit solutions for owners and executives of IT companies, including strategic planning, mergers and acquisitions, benchmarking, best practices groups and management consulting.
The Service Leadership Index™ is the only IT solution provider benchmark that is vendor- and media-independent and focused on driving market-based Solution Provider shareholder stock value. Subscribers to the Service Leadership Index™ can choose to access best practices data regarding General Profitability, Employee and Management Compensation, or Managed Services Sales and Operations, or all three.
What are your views?
Don’t hesitate to share your views, concerns and suggestions with us by e-mailing info@service-leadership.com.
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____________________________________________________________________________ Erick Simpson
A marketing tip for your year-end sales push: IRS Section 179 deductions on computers and software – is outstanding advice. I'm a credit analyst at an equipment finance company and our most successful manufacturer/dealer partners are using this tecnique effectively.
We are swamped with calls at year-end inquiring about Sec 179, so we created a simple calculator: http://www.crestcapital.com/tax_deduction_calculator to answer the most frequently asked question of all - how much can we save by adding different $amounts of equipment or software and using Sec 179?
Posted by: Duke Adams | November 27, 2007 at 05:26 AM