With the traditional project-based business, Managed Service Providers (MSP) have to “reinvent” their business month to month. Go out and sell projects, collect the check, and then start all over again.
In the cloud, transactional billing is replaced by the Monthly Recurring Revenue (MRR) business model – in which new sales build upon each other as you wrap software and services in a neat, predictable monthly subscription for customers.
It’s important for MSP owners to stay ahead of the revenue changes that accompany the subscription billing model. This blog will get you up to speed with the new MRR business and what you should expect to grow a profitable, steady stream of MRR.
Understand the new Monthly Recurring Revenue business
Monthly recurring revenue (MRR) is the income that a company can reliably anticipate every 30 days via collecting monthly software subscription fees. This monthly fee replaces the upfront and maintenance licensing fee in the old business model. The subscription generally includes updates, patches, and new versions of the software when they occur.
This new MRR model gives Managed Service Providers (MSP) multiple benefits.
An MSP that creates MRR streams can achieve a steady cash flow, which can protect the company’s bottom line more consistently than if the company only depends on fluctuating project-related businesses.
MRR reduces the peaks and troughs of your cash flow, offering more predictable and easier budget planning and revenue projection for your business.
And clients benefit from paying a fixed fee instead of variable and sometimes unpredictable IT expenses.
Now, let’s drill deeper into how to monitor the health of your new business model.
Get familiar with your new MRR metrics
Here are the most important metrics you should track as your legacy project-based business turns into MRR in the cloud:
- Monthly Recurring Revenue (MRR): The amount of revenue you expect to receive every month from recurring services.This is the single most important metric that a cloud service provider should be tracking. It will serve as your primary benchmark for progress and indicate how your business grows overtime.
MRR = Total monthly billings in recurring services
- Customer Lifetime Value (LTV): Predictable, long-term profits a company will derive from a customer relationship.Because revenue is earned and recognized over a long period of time, understanding the long-term potential value derived from a customer relationship is critical. The profitability horizon in cloud managed services is longer than for project work, requiring this metric to look further into the future.
LTV = Average revenue per account * Gross margin * How long the customer is with you
- Cost Per Acquisition (CPA): The average amount that you spend for each new customer.It might be tricky to get CPA for sales & individual marketing campaigns. Regular web analytics won’t show you where customers originally came from. You’ll need to have customer analytics which can tie all the data back to the customers so you can see which marketing efforts bring you the most profit. We’ll talk about this in a later blog.
CPA = Total marketing expenses/total number of new customers (over the same period)
- Churn (%): The percentage of customers who leave during a given period (month, quarter, year)If you have a high churn (double-digit) for your managed services, there’s something problematic with your product. Start talking to your customers directly and fix the problem before further investment in acquisition efforts.
Churn (%) = Customers Lost [period]/Total Customers [period]
Tracking these core metrics will give you plenty of insights to act on, identify opportunity and build your business.
Reward your sales pro in the new MRR model
Adopting the subscription-based cloud services not only involves changes in the billing process but also affects the way you sell – or how you should motivate your salespeople.
Commissions provide a great incentive for the MSP sales team, but should those sales pros earn commissions on that recurring revenue – forever?
The obvious downfall can be described as sales laziness. To avoid it, you can introduce sunset clauses — tiered commission rates that fade away over a four-quarter cycle. Each new customer win earns a high commission, while customer engagements that are three- and four-quarters old gradually fade to zero commission rates.
However, many would argue the sunset clauses should never fade a commission to zero. By earning at least a small commission indefinitely, the salesperson is more motivated to stay in touch with the customer over the long haul — potentially ensuring higher customer retention rates and a better customer relationship.