Plugging Hidden Money Drains in Channel Business Models

MSPs and other channel partners follow changes in IT closely — not only to evaluate what their customers need next, but also to shape their own businesses and discover new revenue streams.

As the IT industry moved to the cloud, so did many MSPs and other partners. Channel business models steadily reshaped into something more akin to reseller or broker of cloud services. Their reward for making the shift was steady money every month, known as monthly recurring revenue (MRR), from the cloud providers they represented. But while those deals seem sweet at the outset, they’re already proving problematic over time, especially when a partner wants to sell their business.

A new whitepaper by Enterprise Strategy Group (ESG) warns of revenue and value erosion in from changing terms in channel relationships that aren’t immediately recognized as harmful. MSPs are advised to regularly evaluate their business models and channel relationships in at least an annual checkup to ensure money isn’t lost to hidden money drains.

Asigra’s Eran Farajun

“In a healthy model, incremental margin that would otherwise benefit the cloud provider is transferred to the partner when they deliver the service themselves using their own people, infrastructure and dedicated data center. Importantly, the MSP also retains the ability to evolve and adapt the right services/pricing/margin mix to serve their markets and customers, protecting them from margin erosion over time due to matters outside of their control,” write the analysts who authored the paper.

So how does an MSP, or any partner for that matter, lose money from MRR and channel agreements? One way money can be siphoned away is in a reduced price for the business.

“Many MSPs these days have been in business for a long time and are now looking to unload their business in the next three to five years or sooner,” said Eran Farajun, executive vice president at Asigra, the cloud backup and recovery company.

MSPs looking to sell their businesses soon want to get the highest price they can. But Farajun says that many soon discover the underlying vendors for the services they brokered take those customers and move them to a different broker.

“It’s very easy for the end customer to stop their service and move to a different broker or even move to a different technology. They’re just not as sticky,” Farajun said.

“The buyer of their business then has to expend a lot of energy and effort and money to keep those customers. And that gets taken out of the purchase price. So instead of the MSP getting $100 a contract, just using a number to make a point, they’ll just get $30 a customer contract,” Farajun added.

That’s a near instant deflation of value for MSPs at the point of selling their business. And make no mistake, most MSPs are exposed to taking such a hit. According to Datto’s 2019 State of the MSP report, 44% of respondents said more than half of their revenue is a result of recurring services.

Another way money drains away from an MSP is through the recalculations of margins typically brought about by the same or merger of the vendor.

“For example, maybe a private equity firm wants that margin in their pockets after a vendor acquisition,” Farajun explained. “So they turn to the partners and say, ‘Look, last year you sold $100 … $200 … $500,000 worth of our cloud service, whatever that service was, monitoring, backups, security, VoIP, and so on. And you’ll be getting your 25-30% margin. Next year, if you want to keep that margin, you’ve got to sell 150% of what you sold last year. And if you don’t, well sorry, we’re going to knock your margin down to 17%, 18%, 20%.”

Partners can plug these money drains by …

… staying on top of changing terms in agreements and by safeguarding their clients from vendor poaching.

The underlying reasons for switching to a cloud model and MRR a decade ago were to avoid the heavy lifts and hefty costs of hosting and operating IT services. But today that’s no longer true, and once again bringing services on-premises makes sense for a lot of channel partners.

“It’s something that partners probably should re-examine for entirely selfish reasons, which are they get to control their own revenue and margin. That’s important because a lot of the margins have plummeted in the last 10 years,” said Farajun.

“It’s a lot less to stand up a service because technology has improved, and prices have dropped. There’s a lot more automation. You don’t even have to stand up your own data center. You can basically buy a data center every month from Amazon or Azure, from Microsoft or whatever,” Farajun added.

Partners, however, shouldn’t go too far with that advice either. The point is to develop healthy models for every service you offer.

“It doesn’t make sense to do it for every service; for example, they should not go and stand up their own competitive offering to Office 365. They’re going to get run over. Or Salesforce, or other types of cloud services,” said Farajun.

“VoIP services, network services, security services — these are very common cloud services that a partner should by now, really think about standing up and bringing back in house, so that they can get the economic benefits of doing that from increased margin, tighter relationships with customers,” Farajun added.

Captain’s Chair IT’s Phillip Myers

Where else can MSPs look to maximize their earnings and business value? Philip Myers, director at Captain’s Chair IT, said the three biggest missed opportunities for MSPs are:

However you decide to strengthen your business models, be sure to reevaluate channel partner agreements regularly to protect yourself from vendors looking to siphon your margins or poach your customers. There are several indicators that can tip you off to a need to make a change in agreements and models too.

Beware of declining margins, vendors that send messages to your customers directly and without your permission, vendors that require you to list your customers and their contact information, or if your accountant calculates a value for your business based on earnings that’s well below what you thought it would be, said Farajun.

“All of those are telltale signs that the underlying relationship that you have, or the way you go to business can be improved, can be optimized. But right now, your business is suboptimal,” he said.