As providers of various SaaS products, MSPs sometimes feel “stuck in the middle,” providing the sales and front-line support for such products in exchange for a considerably small margin. We rely heavily on these products and I have always wondered if this explains why many MSPs appear to have such a distaste for the SaaS industry.
Predicting potential profit
Regardless of your opinion, there is one thing that SaaS companies appear to do undeniably well that we can all learn from. Since many of these companies are funded with venture capital funds, they are constantly evaluating their business and their customer value so they can accurately predict future profits and/or valuations. This is an exercise that few MSPs do, even though the calculation is relatively simple.
The metric I am referring to is called the Customer Lifetime Value (LTV). This is the amount of profit that you can expect to earn from a customer for the entire time that you retain them. A simple example of this would be if your customers average $2000/month in recurring revenue (at a profit of 20 percent) and you retain them for an average of three years, then your average customer LTV is $14,400.
These figures are essentially minimum recurring values, since they do not include things such as hardware sales, project labor, or any miscellaneous work. Averaging these would be possible as well, although it would require a large amount of historical data that most MSPs simply do not have.
Shaping your target audience
Once you have a way to predict profitability, there are various uses for this metric. One of these uses is in the development of your target audience at the top of your marketing funnel. When building our MSP firm, we typically tried to market to companies that were 10 employees or more. That’s what we determined to be the minimum value we needed to obtain for the costs that we had.
If you charge a premium and your profit margin is high, then you can likely target any size business that you want. However, most Managed Service companies do not have this luxury. When you look at the numbers from a point of profitability, small clients often require a similar workload, with a far smaller pot-of-gold at the end of their LTV “rainbow.”
This means you may support a customer for a three year retention, only to earn a few hundred dollars in the end. Knowing these numbers is the first step in determining what your breaking point is and what size customer you can comfortably bring on, without it negatively affecting your business.
Measuring campaign success
When you decide to actively market your business, the first thing you often do is set a budget. What I have found through talking to Managed Service Providers is that their budget is more relative to their risk tolerance than it is to the actual costs associated with acquiring a customer. Instead of using LTV to set a target acquisition cost, they simply choose a number that they can afford to spend monthly and then they hope to see a return.
While this might be a comfortable way to manage your risk and cash flow, it is important to have the appropriate expectations for the amount you spend. For example, if you are only spending $500/month on marketing and expect to generate a customer with the lifetime value of over $20,000, then you may be setting yourself up for disappointment.
On the other hand, if you do find yourself generating new customers at a cost of 20 percent or lower than their LTV, then you may want to ramp up spending to capitalize on this opportunity. Without knowing the value of these customers, it is very hard to make these decisions and your window of opportunity may close as a result.
Setting goals for growth
Another way that LTV can come in handy is with setting goals for your company’s potential growth. If you want to grow your revenue to a specific amount, knowing the value of your customers will allow you to work backward and determine how many customers you need to acquire to accomplish this goal. This is also an indication of how much you should spend on marketing and whether or not you should increase your budget accordingly.
The most important part of this process is committing yourself to this level of constant evaluation. Your calculations will probably not be an exact reflection of the true outcome; however, this is to be expected. The goal is to use actual data to make an educated guess, rather than the alternative of making decisions with little-to-no information to support them.
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