In-Depth

Paving the Way

Growing demand and attractive margins have partners of every description jumping into managed services. Should you join them?

• By Rich Freeman
• April 01, 2007

Amy Luby was a managed services provider (MSP) before MSPs were cool.

Luby is a principal at Mobitech, a five-person MSP and Certified Partner based in Omaha, Neb. But four years ago, Mobitech was a struggling sole proprietorship doing project work and break-fix jobs. "I was overworked and underpaid and didn't see a way to scale up," Luby recalls. Her salvation came in the form of a novel idea: providing remote network monitoring and maintenance services for a flat monthly fee. Customers would enjoy reliable uptime and predictable IT costs, and she would be able to support more clients without putting in longer hours.

Though the term barely existed then, what Luby had created was a managed services offering. And it worked. Today, Mobitech has more than 400 clients and Luby is a zealous advocate for the MSP business model. "You've got your recurring revenue, but you also see an uptick in the numbers of projects you're doing," she says. "And if you sell hardware, you also see an increase in the amount of hardware you're selling."

Sound good? You're not alone in thinking so. Rich margins and growing demand have VARs, solutions providers and integrators jumping on the managed services bandwagon. "Everyone says they're a managed services provider now," observes Luby. But what many of those companies are discovering is that while the potential rewards are enticing, becoming an MSP is a long, arduous and often costly process. "It's a paradigm change from the sales perspective all the way through to the service perspective," says Tony Williams, vice president and CTO of RIATA Technologies Inc., an Austin, Texas-based MSP and Gold Certified Partner that used to be a systems integrator. "There's plenty of opportunity for companies that want to go about it the right way, but if you're going to make a half-hearted effort, save yourself the time and heartache."

A Healthy Market
"Managed services" is one of those terms that no two people define precisely the same way, but most experts and providers agree on a few basics. MSPs, they say, perform IT tasks such as desktop management, networking and e-mail administration on a subscription basis. They do most (though not all) of their work remotely, and take a proactive approach to keeping customers up and running; rather than responding to problems, as break-fix partners do, MSPs seek to prevent problems from occurring in the first place.

More and more business customers like the sound of that. According to analyst firm In-Stat, of Scottsdale, Ariz., managed services revenue in the United States will reach $37 billion this year and hit $46 billion by 2010. Fueling that growth is an increasingly widespread belief among decision makers that outsourcing basic IT functions leaves more time for strategic initiatives and core competencies. Indeed, in a September 2006 study from Wellesley, Mass.-based consulting firm THINKstrategies Inc., freeing up IT staff was the top reason executives cited for using or considering managed services, followed by reducing costs and improving IT service quality.

However, rising demand is just one incentive for taking the leap into managed services. Another is the evaporating margins on traditional hardware and software deals. "The product side of the business is becoming commoditized," observes Jeff Kaplan, managing director of THINKstrategies. And today's inexpensive hardware has customers spending less on support, too. "They just throw away a broken machine and replace it," Kaplan notes.

Managed services is a comparatively healthy market to be in, many former VARs and solution providers say. "It's much more profitable than your traditional integrator model," says Williams. Back when RIATA was doing project work, it typically earned four- to five-point margins. Today, its margins average 10 percent to 17 percent. Meanwhile, winning old-fashioned integration jobs has gotten easier too, Williams adds. Even RIATA's best customers used to put new projects out to bid. Now clients regard the company as an extension of their IT teams. "We have no competition when it comes to project work," Williams says.

Flipping the Switch
Still, making the transition from product sales and systems integration to managed services is highly challenging. "There are some huge growing pains you've got to go through," says Luby. For starters, being an MSP requires an entirely new mindset. "You can't do business the way you used to, which is wait for the phone to ring, fix the problem, send out a bill and hope it happens again," says Charles Weaver, president of the MSPAlliance, a Chico, Calif.-based MSP membership organization. Kaplan agrees. When a customer experiences a technical glitch, its VAR is often the last to know, he says, but in the same circumstances, an MSP must be the first. "The whole point of managed services is to prevent things from going wrong and to mitigate the impact of those events when they do occur," Kaplan says. "That requires a different kind of skill and a different attitude."

MSPs must adjust to a new financial model, too. Resellers and solutions providers typically collect their money in lump sums, but MSPs get paid smaller amounts over a longer period. "The revenue stream is much more incremental," notes Kaplan, which can impose short-term cash crunches on some partners as they transition their business models. Compounding that problem is the hefty cost of all the new monitoring, management and service incident tracking tools that an MSP requires. "You're probably looking at a minimum of $100,000 to get started," says Williams. Factor in the uncompensated time you spend deploying, integrating and learning to use those systems, he adds, and your real start-up costs will likely run closer to $500,000. Luby, however, argues that smaller companies can ease into the managed services business more affordably by contracting with third-party network operation centers or help desks at first, rather than setting up their own.

Partners must also adopt new compensation schemes when becoming MSPs. For example, most integrators encourage their technicians to rack up as many billable hours as possible. Under a fixed-price billing system, however, longer hours lead to lower profits, so MSPs must reward engineers for other accomplishments, such as resolving service incidents quickly or achieving high customer satisfaction. Sales teams face pay changes too. "In a project or break-fix model, you generally pay your salespeople a high commission and that's it," says Luby. "In an MSP model, you pay a smaller [initial] margin but it's a recurring margin." Just the same, she notes, you should be prepared to hear some complaints at first when those big commission checks stop arriving.

There are other sales force issues to contend with as well. Managed services contracts are strategic commitments requiring a consultative sales approach, and VARs in particular often find that their salespeople lack the skills to close deals. "[An MSP's] salespeople have to be skilled at selling business services and the value proposition of those services, as opposed to the technical features of products," explains Kaplan.

They must also be comfortable selling to senior executives rather than to the midlevel IT managers with whom they normally work. "We really like to start at the CFO and work our way up," Williams says. "We typically won't even meet with the system administrator." Selling to C-level business leaders requires a softer touch than some salespeople can muster, though, he says. In fact, many MSPs have found that low-key seminars and webinars explaining the merits of managed services work better than conventional sales presentations. "The MSPs we've seen have huge success are the ones that educate" rather than sell, says Weaver.

The Big Question
Just in case re-inventing your business from the ground up wasn't daunting enough, there's another reason to pause before moving into managed services: Microsoft is preparing to do the same thing. Yet while evidence of Microsoft's ambitions in managed services has been accumulating for at least two years, the specific contours of its intentions remain murky.

Microsoft's first foray into managed services was a one-off arrangement with battery-maker Energizer Holdings Inc. of St. Louis, Mo. Under terms of the deal, first disclosed in March 2005, Microsoft agreed to provide desktop, SharePoint and e-mail management services for Energizer's 7,000 PCs via a newly formed unit within its IT department called Microsoft Managed Services (MMS). In May 2006, XL Capital Ltd. a Hamilton, Bermuda-based financial services provider with 4,000 desktops, became MMS's second paying customer. After each signing, Microsoft executives said that their company's ultimate objective was to improve its products by gaining hands-on experience with the back-office challenges its customers face every day.

Last October, however, Microsoft moved MMS and its 500 employees from the IT organization to the Server and Tools product group, signaling an intention to roll out managed services more broadly. Indeed, according to research from the Kirkland, Wash.-based analyst firm Directions on Microsoft, the company is constructing data centers capable of delivering desktop management services and Exchange and SharePoint hosting services to millions of seats. When those facilities will go into commercial operation remains uncertain. "A complete managed solutions platform will not be available for some time, but it's an area of technical focus in [fiscal year 2007]," says Tom Ryan, a senior PR manager at Microsoft. It's also unclear to whom Microsoft plans to sell managed services. "MMS will focus on enterprise engagements in the short term, although we will also explore the feasibility of mid-market offerings," says Ryan.

For most partners, the biggest open question is whether Microsoft plans to deliver managed services itself or through its channel. For now, Ryan will say only that Microsoft plans to manage "a small segment of customers" directly, mostly to provide MMS a test bed in which to refine its software and processes. "That said, Microsoft is a product company first and foremost and has no desire to become a global IT outsourcer," Ryan says. He adds that Microsoft is currently developing an "opportunities and expectations model" for partners that will spell out how they can engage with MMS.

In the meantime, few Microsoft partners are losing sleep over the company's intentions. "I'm not worried," says Chris Plouffe, owner of CSP Technologies Inc. in Winston-Salem, N.C., a Registered Member that's been offering managed services for about a year. "I think the relationship [with Microsoft] won't change much."

Holding the Client
Of course, Microsoft isn't the only industry titan contemplating a move into managed services. "We're looking at the entire IT industry shifting to a much more services-led model," says Julie Giera, a vice president and analyst who covers IT services and outsourcing for Cambridge, Mass.-based Forrester Research Inc. Anticipating that trend, giant tech firms like Dell Inc., Hewlett-Packard Development Co. and Electronic Data Systems Corp. are aggressively constructing massive new data centers of their own. Eventually, Giera predicts, the big players will price all but a few dozen providers out of the managed infrastructure market. "You'll almost have to be a Wal-Mart to do managed services on infrastructure," she says.

Where does that leave the legions of smaller MSPs? Competing on value instead of price, Giera says, especially among small and medium businesses (SMBs). "A lot of small businesses think they're just a number to a company like IBM [Corp.]-and they are," she argues. "The large providers have been trying to figure out how to support the [SMB] market, and they haven't been able to do it." That gives smaller MSPs an opportunity to prosper despite the commoditization of infrastructure services by providing personal attention the big players can't match.

As is so often true for channel partners, then, long-term success as an MSP will ultimately come down to taking good care of customers. "The most important thing that the MSP has with the client is the relationship," says Erick Simpson, vice president and CIO of Intelligent Enterprise Inc., a Gold Certified Partner based in Garden Grove, Calif., that trains and supports tech companies entering the managed services market. "I tell partners all the time that if you're not seen as a true solutions provider and adviser by your clients, then your relationship can go to any other provider, not just a [big one]." Conversely, Simpson adds, partners who keep their clients happy have nothing to fear from even their largest competitors. "Dell is never going to steal a client relationship away from us if we're doing our job right," Simpson says.

Weaver, of the MSPAlliance, takes a similar view. "The analysts predicted five or six years ago that there [were] only going to be five or six big MSPs today, and they were wrong," he says. "We've got tens of thousands of new MSPs emerging worldwide, and there's no sign of them stopping." What that tells you about smaller MSPs is simple, he notes: "They hold the client, and whoever holds the client wins."