Agreement Profitability: Why You Are Losing Revenue if You Aren’t Tracking This Metric Correctly5 Oct, 2015 By: Daniel Martin
In an MSP business, timely, accurate data is king. It can be the difference between profitable relationships and lost customers. Luckily, there are technologies available to connect all aspects of our business and allow us to do more with less by presenting more data than we could have possibly imagined. With technologies like Professional Services Automation and Remote Monitoring and Management, much has been written and argued regarding which metrics are most critical for a service provider to track. While many of them are obvious, not all of them can tell the full story on their own.
While metrics like revenue, sales forecast, and accounts receivable are critical, they are also straightforward and easily understood. In this article, we will touch on one of the most important metrics that can easily be taken or gathered out of context and how to ensure your business’ health is always maximized real-time: Agreement Profitability.
What is Agreement Profitability, Really?
As a service provider transitions from time and materials billing to an MSP model, one of the first key financial metrics that must be tracked is Profitability per Agreement. Basic as it may seem, there are several factors that must be taken into consideration in order to avoid under or overvaluing an agreement (impacting profit, margin, and cost). Specifically, you must look at the impact of effective rate, product bundling, and disparity in contract value.
In case it is new to you, effective rate is the total amount invoiced divided by the number of hours against the contract and defines what your billing rate would be if you were billing hourly, instead of under contract. While it ignores a number of important dependencies in and of itself, it is a good place to start understanding profitability.
Another MSP trend impacting the true profitability of an agreement is the bundling of many different items into a single contract. HaaS (Hardware as a Service), BDRs (Backup and Disaster Recovery Devices), SPLA (Service Provider License Agreement) licensing, SPAM services etc. are often now part of a single service agreement. Almost all of our core agreements have some elements of hard costs associated with them. If we do not take those costs out of the equation when looking at profitability we do not have an accurate picture of whether we are actually making money or losing money.
Yet another key issue impacting agreement profitability is disparity in total contract values. Often when determining agreement profitability, people will look at all agreements in total. While simpler, it hides the details within each agreement and skews the results. We have agreements as small as $1,000 per month and as large as $60,000 plus per month. If we are overpriced, not performing enough service, or not providing enough value on one single contract, we risk losing the customer on renewal. On the other hand, if we are servicing a customer that should be re-priced or let go, we are losing money, losing capacity, and jeopardizing other customer relationships.
These things are never seen when looking at agreements as a whole. You must look at each agreement on its own to understand your true profitability, but monitoring this can be a time consuming endeavor.
This is where Labor Loaded Gross Margin Percentage (or LLGM %) comes in. Though the term sounds slightly scary if you aren’t familiar with it, the calculation is fairly simple. You start with the total revenue from a contract, subtract all product / hard costs, and subtract all of your actual costs of labor based on the resources who spent time against the contract.
This gives you your total true margin. You then divide the total margin by the total revenue to find out your percentage of margin. Over the last 30 years, we have found that you are doing well if you are in the 60% + range. If you are over 75% you are in danger of losing the customer, and if you are under 50% you are probably losing a lot of money. Your specific numbers may be slightly different but these provide good benchmarks that you can tweak to your own service delivery model.
Don’t Be Afraid to Look at the Meaning Behind the Metrics
All key metrics exercise the law of yin and yang - for every action there is an equal and opposite reaction. The easiest way to misrepresent the profitability of any contract is to not work on it, or misallocate the work. That is where balancing metrics like utilization by member and customer satisfaction make a tremendous difference.
While much has been written regarding the metrics that drive a successful service provider, most of it focuses on individual metrics and leaves out a number of critical factors relating to dependencies and the combined process. When overlooked, you risk having what you believe to be accurate metric data actually masking problems and giving you a false sense of confidence. To prevent things from falling through the cracks, you need to really understand the meaning behind the numbers.
Daniel Martin is Vice President of ConnectSMART. For detailed company information, please visit www.connectsmart.com