How capital affects MSPs and technology services companies

Vendors that get acquired promise a lot of things but don't always deliver. Here are several recommendations to help MSPs and technology services companies adjust their strategies accordingly.

Dave Sobel is the host of the podcast "The Business of Tech" and co-host of the podcast "Killing IT." In addition, he wrote Virtualization: Defined. Sobel is regarded as a leading expert in the delivery of technology services, with broad experience in both technology and business.

This week, Sobel looks at how capital can alter a market, especially when left unchecked. He also provides managed service providers and technology services companies with actionable advice they can implement to remain relevant and be able to overcome any changes due to private equity acquisitions.

Transcript follows below

Dave Sobel here with another perspective on why capital matters and how it changes markets and why you in technology services should care.

A look at a recent DoorDash story

Have you heard the story of the pizzeria owner who made money buying his own pizzas from DoorDash?

Reported in the newsletter The Margins, this story starts with the tactics of DoorDash to bully restaurants into signing up customers. The company creates delivery options on a restaurant's Google Listing, and then the complaints come in from customers that they can't get delivery.

In this case, however, DoorDash incorrectly priced the pizza -- a $24 pizza was listed as $16 by DoorDash -- and in true Wall Street trader fashion, they quickly realized what they could do.

If someone could pay DoorDash $16 a pizza, and DoorDash would pay the restaurant $24 a pizza, he could just order all day long from himself, clearing $8 profit per pizza. They did it -- and it worked, multiple times, even trying to just order pizza dough for pure profit.

Ranjan Roy, the author of The Margins piece, observes that DoorDash lost $450 million generating $900 million in revenue. Delivery was working just fine before DoorDash and companies like it came in with this capital.

Quoting Roy in the piece: "You have insanely large pools of capital creating an incredibly inefficient money-losing business model. It's used to subsidize an untenable customer expectation. You leverage a broken workforce to minimize your genuine labor expenses. The companies unload their capital cannons on customer acquisition, while the Uber-Grubhub news reminds us, the only viable endgame is a promise of monopoly concentration and increased prices."

"The more I learn about food delivery platforms, as they exist today, I wonder if we've managed to watch an entire industry evolve artificially and incorrectly."

The lesson here is that capital can change the entire direction of an industry, particularly disproportionate amounts of capital. In this case, the drive to make money has been entirely redirected by these players to drive instead to scale.

Relevant technology services acquisitions

Now, let's look at what's happening in the technology services space, particularly tools vendors focused on managed services.

When we look at the history of companies here, you have a number of founder-driven companies which are designed to solve a problem and build a traditional business. Austin McChord of Datto, Arnie Bellini of ConnectWise, Gavin Garbutt of N-able, Doug Wilson at HoundDog, Peter Sandiford at Level Platforms, all are founders that identified a problem, built something and went forth to solve a problem and generate revenue doing so.

Over time, each sold. HoundDog in 2009, N-able and Level Platforms in 2013, then HoundDog again in 2016, Datto taking investment in 2015 and selling in 2017, and ConnectWise in 2019, all eventually ending up in the hands of private equity firms rather than their founder-owners.

Each time, there is a press release.

The founder will say something along the lines of "This will provide a whole new set of capabilities and accelerate our growth," and the acquirer says something like, "This will take the company to a new level."

Seriously, go look at the press releases. Looking back on each, it's like a set of Mad Libs -- you can just replace the nouns for the company names and the founders, but they all read identically.

At their core, the promise is "we will move faster, deliver more and do more with this money."

And none of it is actually true.

You can tell I've spent a bunch of time reading press releases lately, because while all of these new companies have done plenty in terms of issuing releases, more often than anything they are discussing who their leadership is or how much money they have made, not their development of anything new or innovative as we were promised.

And there is a reason for that. Just like in the food delivery example, private equity money isn't here to build something and solve a problem. Private equity money has changed the game.

A PE investor comes in with one design -- to take a company, accelerate its revenue growth, make it bigger and sell it. "20% growth" becomes a mantra, and there are three basic levers to pull here.

Lever one is sell more. You'll often see a lot of investment in sales and marketing teams, because selling more is good for increased revenue growth. You can also raise prices -- which, shocking, they do. Of course, it's hard to get new customers, so thus the second.

The second lever is to acquire new things to sell to your existing customer base. This lever is pulled because it's really hard to get 20% growth on large sales numbers, and the easiest way to do it is buy something and then sell that new thing to your existing customers, as we know it's far easier to sell to an existing customer than a new one.

Finally, you make it leaner -- you cut expenses by headcount and anything risky. You know what costs more and is risky? R&D. Building something new is hard, and it gets in the way of driving profitability. It's way easier to just go buy things and roll that in than it is to build something.

Thus, you don't see a lot of building of new things.

Now, we were promised that. Every single time. Here are the quotes:

  • "This merger marks a natural step in our evolution as we continue to bring more managed service offerings to the channel."
  • "This unique combination of talent with a track record of success marks a new chapter that will make an even bigger impact for our Managed Service Provider partners, by delivering an unprecedented set of capabilities for them to serve millions of small businesses in the future."
  • "Our combined teams will utilize our deep domain expertise and industry-leading data analytics capabilities to deliver breakthrough innovations to our customer base of the world's leading MSPs."
  • "We will continue to invest in our partner community and provide the solutions they need to deliver technology as a service to the world."
  • This "will allow us to accelerate growth and provide tremendous long-term value to managed service providers and the small businesses that they serve."

I didn't put any names on these, because they are all the same! They're actually entirely interchangeable! I could put one quote into the other's press release, and you wouldn't know! These are five distinct quotes taken right from press releases for acquisitions I mentioned before.

And you can't tell the difference.

In these press releases, I was promised a flying car. Where is my flying car?

Let me be clear -- I don't blame a single one of those founders for selling and taking their windfalls. I hope they are enjoying new lives, houses, trips and have fantastic lives. They worked hard, they built something, and they added real value.

But you know what else -- they are all gone.

The problem is that this change is not just business as usual. Here is why I think all of this private equity money is dangerous for solution providers. 93% of all solution providers are doing less than $5M in revenue. When their primary vendors were similar to them -- founder driven and looked a lot more like small businesses than big ones -- they were much more in alignment. What was good for the provider was good for the vendor, and vice versa.

But that script is broken now. The market doesn't change. Technology doesn't change. New versions of the same products do not drive a market forward.

These companies position themselves as core to the model … but where are they innovating? Are they helping you in the cloud? With Chromebooks? Virtual desktop infrastructures? Azure? AWS? Google Cloud? Some are still struggling with virtualization -- a technology I wrote a book about more than a decade ago.

This is dangerous. Solution providers, which as a reminder are less than $5M in revenue in general, are not the ones who are going to be investing significantly in new R&D. They certainly aren't creating new products -- they are creating new service bundles but do require the creation of new technologies to do that.

And they aren't going to get that from companies driven by private equity. The money has messed up the dynamics of the market.

Recommendations for customers of acquired vendors

First, I'd reevaluate your relationship with these vendors. If you are riding the sugar high from the "relationship" you have with them, make sure you're not living in the past. They have financial goals to meet -- that's what matters. Those personal relationships with the founders are long gone. That rep (at any level) could be gone in a second. You need to evaluate your interactions purely based on the value they provide now, not previously. Sweat equity isn't worth anything.

Second, ensure you aren't locked into their ecosystem in a way that jeopardizes your business. I recently heard a provider be dismissive of selling a customer a Chromebook solution because they "don't make money off it" and "can't manage it." If services dollars are your core, you can make services money off any technology -- regardless. Your tools budget is way lower than your labor budget, and that labor matters so much more

Thus, two measurements. What would be the impact if they raised prices with no additional value, and what would be the impact if you needed to switch?

You may think retraining is a high cost, but the lifetime cost of tools is far higher. An increase in cost quickly offsets that retaining cost.

I say this because you have additional needs -- the future of the industry does not look like the past, and right now, some of these vendors look like relics of the past, with what looks more like maintenance on their product lines than investment. They are not going to bring you anything new, and you need to continue to innovate. Going deeper into their ecosystem is not going to help you there.

If I was Microsoft, I could wipe them out with a few smart investments. This is the threat you need to worry about -- a vendor that becomes interested in this space at that size and scale is quite close.

Thus, my final recommendation is a hard analysis of the reality of change. You think it's really hard. But is it? A new, eager, upstart competitor without the legacy backlog can come into your space. Think about the MSP you would build if you were starting -- mine would be super lightweight and wouldn't be using any of the legacy tool kits. Having launched my own new business in the past 12 months, the tools are trivially simple to get up and running. The market is very different now, particularly if you've had a tool for a long time.

If you're a vendor related to this space, I'm issuing new recommendations

Don't worry about these ecosystems. Integration used to be really important, but it's actually a lot less so now, because it's difficult and takes a way a lot from your agility. You're devoting precious development resources to something that, in my mind, is becoming less valuable. You're more likely to be bought by them than need a real integration, and since you need to do it four times to integrate into each ecosystem… don't waste your time. Instead, find a compelling differentiator so the providers need you no matter what. If you're driving revenue, that's the more important piece.

If you're nervous about that strategy, then do one thing. Make billing easy. Make it really easy to put your usage numbers onto a provider's bill. If you solve just that, everything else can be addressed. The technical integrations are really nice to haves -- the single pane of glass is marketing, not reality, so if you make billing work, you're solving the biggest pain point.

Final thoughts

Now, some final thoughts for those solution providers and technology services companies. Do not be afraid of these companies. I've spoken with too many providers that think their value goes away if they lose their toolkits, or that they need these companies. You don't. Your customers don't even know which tools you use; and, remember … you're the customer. They call you partner because they want you to feel that way, but you're the customer. You pay them, and they have to deliver. If they don't deliver, move on. You have the power in this relationship, and you should leverage it.

About the author
Dave Sobel is the host of the podcast "The Business of Tech," co-host of the podcast "Killing IT" and authored the book Virtualization: Defined. Sobel is regarded as a leading expert in the delivery of technology services, with broad experience in both technology and business. He owned and operated an IT solution provider and MSP for more than a decade, and has worked for vendors such as Level Platforms, GFI, LOGICnow and SolarWinds, leading community, event, marketing, and product strategies, as well as M&A activities. Sobel has received multiple industry recognitions, including CRN Channel Chief, CRN UK A-List, Channel Futures Circle of Excellence winner, Channel Pro's 20/20 Visionaries and MSPmentor 250.

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