2022 year-end review: Lessons learned from best-in-class MSPs
2022 was an exciting time for managed service providers (MSPs). Having not only survived, but thrived during the pandemic, MSPs showed great revenue growth over the last four quarters. In this blog, we will look at insights to indicate if we are in a recession, what the MSP M&A landscape looks like, and four things you can start doing to improve your performance this year.
Should you be concerned about an upcoming recession?
Before we begin, there has been much talk in the news recently about a potential recession. The World Bank has revised the 2023 global economic growth outlook to 1.7% from its earlier projection of 3%. This puts us in the third weakest pace of growth in nearly three decades due to the rise in global recessions and financial crises from the COVID-19 pandemic. However, based on our industry data (collected from Service Leadership Index®, the largest quarterly and worldwide benchmarking database in the industry), the MSP industry is not currently in a recession. In fact, there was great revenue growth in 2022, with an increase in gross margin dollars and adjusted EBITDA.
Source: Service Leadership Index®
If there is a recession coming, best-in-class MSPs (those in the top 25% of profitability) will likely fare well because they are running their MSPs at a much higher Operational Maturity Level (OML). Thus, even with the likely revenue impact, they have processes and strategies in place to tackle such situations. But the same cannot be said for MSPs in the median or bottom quartile of profitability. In the event of a recession, it would be much more devastating for those MSPs.
What is the current MSP M&A landscape?
When the world went into pandemic lockdowns in March 2020 due to COVID-19, the M&A market cooled down rapidly in Q2 and Q3. By Q4 2020, the market started heating back up again. By early 2021, it was red-hot and continued through much of 2022, despite interest rate hikes in mid 2022. For 2023, the market will depend strongly on how interest rates will increase and the state of the overall economy. While the market will still be good, it won’t be as red-hot as the last couple of years.
In the private equity (PE) space, PE-backed MSPs had three-times year-over-year growth in total revenue compared to the average MSP, due to rapid acquisitions. In product resale growth, they were almost five-times the average MSP. This shows that while there is an ongoing acquisition, these MSPs are also upselling and getting projects out the door. However, the rapid pace of acquisitions creates significant integration work for PE-backed MSPs, which can affect all aspects of the business. This model is continuing to grow as new PE firms continue to enter the MSP space.
See related content:
Understanding the Process of Buying and Selling MSPs
How to Ensure Successful M&A Integration
Source: Service Leadership Index®
Unpacking the formula for success: 4 things best-in-class MSPs did differently in 2022
1. Double down on capturing managed cybersecurity revenue
Top MSPs have roughly doubled the percentage of their total revenue from managed cybersecurity. They are ahead of the curve in packaging offerings with their existing services, a trend we started seeing in 2020. To attract prospects, these MSPs have fewer packages but include more cybersecurity services to stay competitive. On the flip side, low-performing MSPs still sell their managed service offerings with fewer cybersecurity portfolios, choosing to sell it as an add-on.
See related content: How to successfully sell cybersecurity
This is not much different from the evolution in the industry that we've seen over the last 10 to 15 years with products like backup, spam filtering, and other services that were once optional add-ons but are now included.
Source: Service Leadership Index®
2. Push fully managed service contracts
The best-in-class MSPs have almost 70% of their managed service clients on their all-in, most fully managed service contracts. This strategy is a win-win approach for both MSPs and their clients. Contrary to many other business models, the most successful MSPs have less products that they try to sell their clients, with many best-in-class MSPs now only offering one, fully managed contract option to prospective clients. This allows these MSPs to focus all sales and marketing energies on finding the clients who will value these services the most and to not sell less profitable, more difficult to service agreements. Today, even the bottom quartile MSPs are getting better at this as they are now selling over 50% of these types of contracts. This is a great trend for the industry’s future health.
Source: Service Leadership Index®
See related content: What I Wish I Knew When I Started Managed Services: Standardization
3. Leverage variable compensation strategically
When comparing variable pay and total we found that the top-performing MSPs are much better at leveraging variable pay for both staff and manager positions. They've learned that tying a higher percentage of TAE to variable pay is essential to driving results within the business.
With access to specific metrics, MSPs can set up incentives to empower employees to drive the overall performance of the business. Giving your employees specific goals to work towards makes them more productive and efficient. In today’s competitive labor market, a robust variable pay structure can attract and retain high-performing employees. In doing so, MSPs can attract and retain high-performing employees to address the global talent gap while ensuring the success of their business.
4. Fight inflation with best-in-class price increase management methods
We’re seeing best-in-class MSPs use 4-5% for annual price increase percentages. Incidentally, we recommend using 3.9% or 4.1% instead of 4% and 4.9% or 5.1% instead of 5%. This is because clients tend to believe that these numbers are tied to inflation, and there is a science to this calculation.
Many MSPs are afraid that will inevitably lead to the loss of clients, but this is a false assumption. It’s important to design your pricing strategies based on the increased cost of your operation during an inflation. By being upfront with your customers about your increased cost, particularly in compensation, you can demonstrate the value of your service while maintaining profitability.
As an MSP, there is always room for growth and improvement. By examining the performance of the best-in-class MSPs, we can learn from their successes and continually strive for excellence. At Service Leadership and ConnectWise, we’re constantly dedicated to the success of IT solution providers. As a result, we've developed Business Management solutions including our award-winning PSA, an unparalleled integration to ConnectWise CPQ™, along with industry profit and performance benchmarks, KPI dashboards & reporting and IT documentation. See how ConnectWise gives you in-depth insight into your business for better decision making in our on-demand demo.
About Service Leadership
Service Leadership, Inc.®, a ConnectWise solution, publishes the leading vendor-neutral, Solution Provider financial and operational benchmark: Service Leadership Index®. This includes private diagnostic benchmarks for individual Solution Providers and their business coaches and consultants. The company also publishes SLIQ™, the exclusive web application for partner owners and executives to drive financial improvements by confidentially assessing and driving their Operational Maturity Level™.