Many business owners and MSP leaders look at their financial metrics and wonder: “If this one number looks good, does that mean my business is truly profitable?” In our recent Office Hours session, we tackled this very question, breaking down the nuances of profitability beyond a single metric.
The Challenge of a Single Metric Perspective
Larry Cobrin shared a common scenario: an MSP leader sees a strong effective hourly rate and assumes everything is fine—yet at the end of the month, they struggle to make payroll. Why? Because profitability isn’t determined by one number. Several factors contribute to financial success, including efficiency, gross margins, overhead, and utilization.
For example:
- Effective hourly rate may look good, but if engineers are only billing 50% of their time, your efficiency could be suffering.
- Agreement efficiency could be high, but if service gross margins are low, corporate overhead or administrative costs could be eroding profits.
- Service gross margin might be strong, yet overhead expenses such as excessive management salaries can still drag down overall profitability.
Breaking Down Key Profitability Metrics
Larry walked through several key metrics, highlighting how they interconnect:
- Effective Hourly Rate vs. Agreement Efficiency – Effective hourly rate measures revenue per hour worked, while agreement efficiency ensures you are charging appropriately for time spent. A high effective hourly rate without strong agreement efficiency could indicate pricing .
- Agreement Efficiency vs. Service Gross Margin – Even if agreement efficiency is solid, if service gross margin is low, engineer costs, poor utilization, or high service overhead may be the culprits.
- Service Gross Margin vs. Total Gross Margin – Total gross margin includes both service and product sales. Selling large amounts of low-margin products can drag down overall margins but may still be profitable in absolute dollar terms.
- Service Gross Margin vs. Overhead – Even with excellent service gross margins, high non-billable overhead costs can eliminate profits. Investments in buildings, cars, or administrative staff can quietly erode cash flow.
The "Pathway" Approach to Profitability
Instead of focusing on a single metric, MSPCFO encourages businesses to take a “pathway” approach:
- Start by identifying unprofitable clients. A good place to start is MSPCFO Segments → Client report.
- Dig into why they are unprofitable—underpriced agreements, high service hours, or poor utilization. One report to turn to is MSPCFO Efficiency → Agreement Drill Down report.
- Make targeted improvements, such as repricing, improving utilization, or optimizing service delivery.
One client example illustrated this well: Their bottom 20% of agreements were dragging profitability down. However, by focusing on adjusting these agreements, they saw a $20 per hour improvement in their least profitable clients—boosting their overall bottom line.
Key Takeaways from the Q&A
The Q&A session covered additional insights:
- How broad or narrow should profitability tracking be?
- Use a layered approach: track overall profitability but also dig into individual clients, agreements, and product lines to spot improvement areas.
- How does product margin impact profitability?
- Product sales can distort gross margins but still be highly profitable. Understanding the balance between service and product margins is key.
- Can account managers track profitability?
- Yes! MSPCFO allows filtering data by account manager to see which clients contribute most to profitability.
- What about sales commissions?
- While no standard commission model exists, MSPCFO is open to developing tools if a widely accepted approach emerges.
The key takeaway from this discussion? No single metric tells the full story of profitability. Instead, successful MSPs take a holistic approach—looking at multiple dimensions and continuously refining their financial strategies.
About MSPCFO
Winner of both the Partner Innovation and Partner Advocate awards at IT Nation Evolve 2022, MSPCFO is a business intelligence platform designed to solve the unique profitability and productivity challenges managed services providers face. Since the application’s introduction in 2014, MSPCFO has helped hundreds of MSPs and TSPs in the United States, Canada, APAC, and Europe identify improvement targets that directly boost their bottom line. Founder and CEO Larry Cobrin’s consulting, investment banking, private equity and product management experience coalesced in his development of the MSPCFO software and business model.
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