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MSP business model and financial lessons learned in pandemic

MSPs are facing financial uncertainty due to the pandemic. Industry experts offer advice on managing the pandemic's impact and preparing for hard times.

The MSP business model, by its very nature, can be resilient. But that doesn't mean the COVID-19 pandemic hasn't affected the financial health of managed service providers -- some more than others.

In early April, the Small Business Administration launched the Paycheck Protection Program (PPP). The aim of the program was to help small businesses facing pandemic-related financial challenges meet payroll expenses, with loans 2.5 times a business's average monthly payroll costs. In addition to payroll, applicants could use the loan for rent, mortgage interest or utility payments.

Many MSPs fit the criteria for PPP loans and needed the help, especially if their customers couldn't meet payment obligations.

In addition to applying for PPP, many MSPs took other steps to improve their financial prospects. Here, we delve into how industry experts think the pandemic affected the IT services industry, where government assistance could and could not help, and what's been learned over the last few months. Experts also provide tips to help keep MSPs in business now and in the future.

How the pandemic has affected the MSP market

Overall, MSPs that don't derive a large portion of their income from heavily affected vertical markets have generally been able to stay the course. Charles Weaver, co-founder of the managed services industry association MSPAlliance, learned anecdotally that MSPs have put most discretionary projects on hold since mid-March, but said, "I have heard of no MSP reporting on a wide scale [that] managed services clients [were] leaving."

Early in the pandemic, Weaver said some MSPs received requests from clients to adjust their contracts down. "But just a few," he noted. "We talked to quite a few people in the early days of this. … After that, we didn't hear of a tailspin." There was an adjustment period and then it normalized with some increases in managed services. "All things being equal, those were fairly good reports," he added.

Weaver also didn't hear of any MSP reporting layoffs -- at least, as it related to their managed services operations. "Now, when you get to a larger MSP organization that has more divisions than just managed services, we're hearing some reports [of layoffs] if they had a VAR division selling hardware or software, for example," he said. "[VARs] are seeing pretty hard hits." Core managed services remain largely flat or have grown slightly, however.

Top IT spending drivers in 2020

"It's interesting, [when] this all started, I was definitely of the opinion it was going to be horrendous,'' recalled Dave Wilkeson, CEO at MSP Advisor, which provides coaching services for MSP financial performance and service delivery. "I was trying to keep a positive attitude, but I saw bad things on the horizon."

It hasn't turned out that way for most MSPs, Wilkeson said. Certainly, for those in the retail and travel industry, it has. But MSPs overall, "haven't been impacted nearly -- financially, at least -- to what I would have expected. Yet."

Wilkeson said he has seen issues mainly around billable work and some project work going into delay mode. "New sales have kind of paused, but it hasn't had the significant negative impact" he said he expected.

"I think our industry, compared to non-MSP SMBs, was absolutely more prepared,'' he noted. Many MSPs already used cloud technologies and remote access tools because they work remotely with most, if not all, of their clients.

"I think [the pandemic] was more of a cultural hiccup than a tech hiccup,'' he said.

Larry Walsh, founder, CEO and chief analyst at the 2112 Group, has taken to calling the pandemic "the tale of two cities. Much like you're seeing on Wall Street, some tech companies are doing very well and there are others that are not. It's the same with the MSPs and resellers."

Any MSP still, as of June 2020, not doing anything significant in security is missing the boat and I think they will become really irrelevant.
Charles WeaverCo-founder, MSPAlliance

When the pandemic hit, MSPs saw a customer demand for security, collaboration, cloud infrastructure and cloud apps. MSPs positioned with those technologies in their portfolios have done very well, Walsh said. "The ones that didn't do well were too vertically focused or not diversified, meaning they had few offerings but not a complete portfolio."

At the start of the pandemic, 30% of channel partners had two months or less of cash on hand, according to 2112 Group research. Walsh called this "astounding, because the best practice is three months," which only 56% of channel partners had on hand.

"So, 25% to 30% of the channel was in real fiscal distress and still are,'' he said. "There's been a number of smaller businesses that have had to curtail operations."

Walsh's firm is also hearing indirect "background chatter" that some partners are trying to find buyers because they don't have the capacity to continue on with the economic disruption.

Government assistance

The Federal government designed PPP to help keep small businesses' workforces intact and employed. Under the program, an SMB can receive a loan based on the average monthly payroll costs from the previous year, according to Courtney LaLone, principal and CPA at Bernard Robinson & Co. The government will forgive 100% of the loan if the SMB follows the program's guidelines and pays attention to headcount during the forgiveness period.

Reducing headcount below the total used to apply for the loan and not rehiring these employees prior to the end of the forgiveness period affects the forgivable amount, LaLone said. If total payroll costs do not meet the 60% threshold of the loan, the amount forgiven can be affected.

"During the covered period, the borrower is going to want to monitor the costs that qualify under this loan and make sure that they have all of the documentation saved to support the amounts that will be used to determine the forgiveness total,'' he advised.

This loan can be critical to working capital and provide access to cash that would have the lowest cost associated with borrowing the funds, LaLone said. "At a 1% interest rate, there isn't another lending product out there for MSPs or small businesses, in general, that offers access to a loan at such low rate."

The ability to maintain continuity during this uncertain time "could play a significant role in the retention of their [MSPs] customer base and possibly allow them to increase their market share,'' he added.

IT spending by technology in 2020
Coronavirus pandemic has had an effect on expected IT spending in 2020.

In addition to the PPP, Wilkeson said a lot of MSPs have also taken advantage of the Economic Injury Disaster Loan Emergency Advance program.

However, several small MSPs and sole proprietors have been put at a disadvantage because initial government pandemic aid was not geared toward them, Walsh noted. Even now, he said, those programs can be "fairly inaccessible" because of the complexity of applying. Some MSPs he has spoken with "don't want to deal with the headache."

The MSPAlliance took an initiative to educate its MSP members about the PPP and how it works, and, according to Weaver, "a number of our members reported verbally that they went out and got a [PPP] loan pretty early. So, they're protected for a couple of months."

Now that many MSPs have received this "safety net," Weaver said he is cautiously optimistic, because he's hearing MSPs are starting to get very busy again.

Lessons learned and tips for keeping a business afloat

If the pandemic has taught MSPs anything, it is that many need to rebalance their client portfolio and rethink their service offerings.

First and foremost, MSPs that thought carrying a lot of hardware was a good idea learned it wasn't, Weaver said. "So, if you were a classic VAR and maybe did 10% to 20% of your business in managed services and the rest in hardware and software resale, you probably didn't do well and had a hard past few months."

MSPs with a lot of monthly recurring revenue "were far better off and far better prepared to weather this storm than any other business in the IT sector,'' he added.

Furthermore, "moving forward, I think the justification for the managed services model is going to be very pronounced," Weaver said. He added that he believes customer organizations will now rush to both begin using MSP services and deepen their dependence on them to as high as 60% or more "because it's a safety net." This presents a unique opportunity for MSPs to go after other sectors that are operational and IT dependent, he said.

To do so will require a shift for tech providers that still have a large segment of their business in non-managed services and non-recurring revenue, Weaver said. MSPs might also realize they need to review the nature of their existing client services. For example, Weaver suggested MPS tell these clients, "'I'm not going to just to do break/fix work for you. It's not just bad for me financially, but it's risky for you and your [end] clients for us to just do piecemeal spot repair work. Let's do something more formalized.'"

Those MSP business model changes are necessary, he explained, noting how "we have learned over the last 18 months that the cyberthreats facing all industries globally are such that MSPs have to take a step back from those unwilling to invest in cybersecurity.

"It's getting to an inflection point where MSPs are at risk if their clients are unwilling to practice good, safe cyber hygiene,'' Weaver continued.

A lot of MSPs took advantage of the ability to retool their operations over the last three months and get their houses in order, he said. "Any MSP still, as of June 2020, not doing anything significant in security is missing the boat and I think they will become really irrelevant," Weaver explained.

Wilkeson recommended his clients engage in one-on-one conversations with business owners of the companies they service much more than they're used to doing. It's very important right now to learn from clients what problems are occurring and whether those issues might affect contracts, he said. And so is showing empathy.

From an operations standpoint, he suggested MSPs be "really hyper-focused" on their accounts receivable balances, watching for negative trends and being on top of clients that traditionally haven't been slow to pay.

There's no blanket solution for MSPs to offer their clients financially, Wilkeson noted. "But being aware and knowing what's going on with those clients and being willing to negotiate with [them] to help them through all this is important," he elaborated. "You don't want to be seen as the bad guy in the relationship, but the trusted partner."

That will help you in the long run, Wilkeson said.

Walsh recently gave a presentation, which he said he "got a lot of flak for," about how MSPs should not be worrying about profitability right now. His advice was to "stop thinking about arbitrary margins and hitting a profit target. … Maintain your revenue and cover your bases and profit will come."

Like Wilkeson, Walsh said he thinks it's important to understand your customers' needs and help them plan and earn their loyalty and trust. He added that MSPs should also work with their vendors and distributors because they can often extend payment terms.

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