Top Reasons for Margin Erosion and How to Avoid Them

LEARN HOW MATURE MSPS KEEP PROFIT MARGINS HIGH, EVEN DURING ECONOMIC DOWNTURNS

By: Shawn Sailer, Liongard

What do you think is the number one thing on the majority of managed services providers (MSP’s) minds right now? If you thoughtabout a gradual reduction in gross profits over time, also known as margin erosion, you would be correct. While some of the top managed service providers in the industry continue to see sales and profit margins soar, many more MSPs are struggling to even meet their break-even point. These MSPs are working harder than ever with less to show for it. What exactly is the reason for this struggle?Even more importantly, how can managed service providers combat margin erosion and see their profit margins begin to rise again?

Combating Margin Erosion

While not every problem that can potentially erode margins is predictable, we can work to address the ever-evolving business model in order to halt a gradual reduction in gross profits over time.

Common best practices that aim to combat margin erosion would be:

1. Creation of strategic sales plan
2. Thorough management of risks
3. Optimization of company
4. Centralization of tasks
5. Increased employee engagement

What Is Margin Erosion?

Margin erosion can be defined as the loss of margin that occurs once the sale of an item has taken place, and that item happens to have a profit margin that is lower than expected. In simpler terms, margin erosion is a gradual loss in a business’s profits over a period of time.

Causes Of Project Margin Erosion

Margin erosion can be caused by many different factors. Whether it be internal or external theft, human error, a company’s policy changes, new legislature, or shifts in the national and global economy. While not every risk that can lead to margin erosion is avoidable, there are things that can be done to prepare for many of the different possibilities that contribute to this loss of margin.

4 Tips On Avoiding Margin Erosion

Though margin erosion cannot be avoided entirely for every firm. There are many steps a company can take to mitigate the risks many business projects are commonly susceptible to.

1. Establish Repeatable Processes for Providing Accurate Cost Estimating

Creating realistic estimates is an important first step when planning for a profitable business project. The best way to do so involves having an accurate understanding of the project’s expenses. While cost estimating sounds simple in theory, the understanding of a project’s limitations, and overall price is an extremely important aspect to account for. Liongard helps with this because you will have visibility into your clients’ environments so you will know what is there before you estimate the project.

2. Proactively Manage the Change Order Process

Unrealistic goals are one of the primary reasons business projects can lead to margin erosion.

Change orders are commonly needed due to:

• Miscommunication or lack of communication between project team members
• The accepting of client scope changes without a fully realized knowledge of changes potential financial challenges

If a business addresses these common change order issues effectively, many of the profitability risks can be reduced.

3. Provide Visibility and Effective Coordination of Resources

Some important examples of critical success factors in the managed services industry include teamwork and productivity. A business in the services industry’s most valuable asset is their employees. This makes proper employee management extremely valuable for a business looking to maintain profitability.

4. Arm Yourself with Information Necessary to Proactively Respond to Cases of Margin Erosion

Project managers and the business at large will benefit when they have access to the tools to create an effective budget, realistically monitor spent time, adjust protocols and plans based on required changes, and be equipped with the information necessary to effectively respond to potential project margin erosion situations.

When avoiding project margin erosion, the best fixes all involve a combination of people, processes in place, and tools that need to work together. It is important for businesses to have solutions available that support the collection and analysis of various types of data that can be used in the decision making process.

Margin Erosion Amid COVID-19

Obviously, the COVID-19 pandemic has shaken up the MSP industry. Many providers are scrambling to find new earning opportunities to avoid making cuts. Further, we’re in a new economic cycle, meaning MSPs that originated in the past 10 years have never dealt with an economic downturn.

Back in 2016, MSP consultancy Taylor Busines Group (TBG) recommended MSPs shoot for over 17.5% margin, with 20%+ being preferred; but many MSPs now find themselves operating at about 10% profitability, the new break-even point.

Some MSPs have been able to withstand the upheaval better than others. Those serving a cross-section of industries, and those that have been able to pivot quickly, have fared well; so have those with longer-term contracts versus project-based pricing.

Some MSPs are even thriving right now, taking advantage of the current opportunities brought on by the coronavirus crisis. Those with a strong business development process may find they’re able to accelerate while their colleagues put on the brakes.

How to Drive Profitability in this “New Normal”

According to TruMethods’ owner Gary Pica, a world-class MSP doesn’t leave money on the table. Unrealized profitability directly affects profit margin and can be the difference between break-even profits and 25%+ margins. We’re in unchartered territory, so it’s time to get creative and consider all the options that may help you increase your profit margin.

Here are a few ideas to start with:

• Pay attention to KPIs. Track key performance indicators like customer satisfaction score and first call resolution, and then examine profitability metrics at the client, contract and service levels to gain insight into what you’re doing well and what needs more attention.
• Re-examine your pricing. TBG recommends MSP charge an hourly rate that’s 4.5 times the “hourly burdened salary rate,” which includes taxes, supplies, insurance and other related employee costs.
• Market with a plan. IT management consultancy Bering McKinley’s CEO Josh Peterson says, “High-margin MSPs tend to be thoughtful and consistent about lead generation. Lower-margin providers are far more likely to spend lots of money in short bursts on ill-considered marketing schemes.” Make sure you’re not wasting your marketing dollars and eroding your profits with ineffective spending.
• Embrace the cloud. As we move into a cloud-first world, make sure your MSP takes advantage of the opportunities it presents. In its 2020 State of the Cloud Report, Flexera notes that organizational spend on cloud services is likely to increase 47% from April 2020 to April 2021. Incorporate cloud services into your MSP model to help your customers navigate this realm and ensure data and system security.

MSPs managing clients who use AWS, Microsoft Azure and other services in the cloud can also drive profitability through automation. By setting alerts in Liongard to notify you when security thresholds in these programs are not met or access rights fail to match your MSP’s policies, your staff increases efficiency and avoids costly errors.

• Think outside the box. Though TitanHQ rightly points out that there is little margin in reselling Office 365 services, all is not lost here. Being able to quickly identify and show your customers unused or duplicate Office 365 licenses during the sales process and throughout your relationship with a customer can demonstrate your value and help you justify or raise your pricing.
• Build and manage a standards library. Right now, many MSPs are vulnerable to ransomware and other cyber threats because they deal with security in a reactive manner. When you switch your perspective and proactively address security needs before they become problems, you save so much time and increase profitability. Setting automated alerts to help you maintain standards can also help your productivity, and efficiency, immensely.

Flexing Your Profitability Muscles

Instead of cutting out muscles from your MSP in difficult times, start flexing them. Safeguarding profitability is directly tied to choosing the right partners and tools to help you do more. Liongard helps MSPs increase efficiencies to free up time and allows for further profitability using:

• Automated Documentation, which reduces manual tasks while providing accurate, never-stale data for you to reference.
• Actionable Alerts, which provide notification on issues that need your attention, such as critical changes, security risks and unused licenses that can net your clients additional revenue.
• Reporting and Metrics, which internally show you, quickly and accurately, data across customer environments for more effective issue resolution.

As an MSP provider, we’re conscious of your profitability concerns and offer affordable pricing. (For the efficiency alone it brings, MSPs across the country have said the Liongard platform pays for itself several times over. Read why Bill Knox of ES Consulting says it’s the best investment his company has ever made.) Users enjoy unlimited system inspections, unlimited user licenses and client access, a 30-day satisfaction guarantee and much more. You can quickly see why it’s no risk and all reward.

For more about combatting profit margin erosion, check out TruMethods’ whitepaper on The Science of World-Class Providers, and contact us for a demo to see how Liongard can help you achieve the world-class margins you’re targeting.