As many readers are aware, we are privileged to be the operators of the largest scale expert-led peer groups of Copier Dealers who are pursuing the IT business. We humbly and gratefully count among our clients not only most of the largest independent Copier Dealers, but many others who are pursuing IT.
Each quarter, we benchmark their financial performance in detail: Both their entire business and within that, their IT business (including over 80 IT metrics). We do the same for IT companies; we are in fact the largest scale benchmarker of IT companies in the industry by a wide margin.
In addition, we not only benchmark their financial performance, we also assess in detail, what we call their IT Operational Maturity Level™ or OML. That is, how closely they manage their IT business to the way the top performing companies manage their IT business.
Our clients recently received their Q4-2016 IT financial benchmark results from us, which includes their full year 2016 results as well. We'll share the aggregate view of those results with you in just a moment.
Before we share those results, we'd like to help our friends in the Copier Dealer business, by clearing up some rumors and myths that seem to be in the air. While we're at it, we'll cover some "common sense" approaches to succeeding in IT that have long been proven ineffective or worse, to negatively impact your copier business. We'll explain again, what does work for both sides of the business.
We're not aware of any qualities in Copier Dealer owners, executives or staff which make them inherently unable to be successful in the IT business. At least, not among most we have been privileged to work with.
In addition to this first-hand experience with Copier Dealer people, there are proof cases of success. Marco and Symquest are well-known. There are also other large and smaller Copier Dealers who have successful IT businesses, many of whom you, our kind readers, can probably bring to mind.
Clearly, it is possible for Copier Dealers to have successful IT practices. Then the question is, are these successful dealers — although steadily increasing in number — exceptions? Happily, no. More in a moment.
All our S-L GAMIT peer groups (for Copier Dealers doing IT) meet in Dallas in February. During one of our meetings, one well-travelled Copier Dealer executive said (if we may paraphrase):
Heads nodded around the room; they'd heard similar things of course. Given that the members know that we not only benchmark their IT business, but indeed their entire business, they logically asked what our data shows.
Our data shows that some Copier Dealers do see a decline in their core print revenue as they try various methods of getting their IT sales going. Some, however, successfully grow revenue in both businesses.
The way to successfully grow both is proven. Sadly, there are still Copier Dealers attempting to grow IT sales in ways that (predictably) negatively impact copier sales. We will discuss both later in this newsletter.
What's distressing about what was reported to have been said, is that it's both empirically untrue. It's based on a lack of understanding about what sales model does work successfully for both sides of the business.
It's human nature to fill in blanks with the worst possible assumptions. Most Copier Dealers have limited exposure to IT companies and their executives, so they understandably assume that IT executives must be good at their core business.
Of course, human nature is such that, in any population, some are very good at what they do, some are ok but not great, and some are not very good at what they do. This is the case in the IT industry.
We are working on the 2016 aggregate results for IT companies. The chart below shows the top quartile, median, and bottom quartile Adjusted EBITDA for IT companies whose predominant line of business is Managed IT (that is, the "MSPs") for eight years ending in 2015:
As you can see, one quarter of MSPs have earned about 18% adjusted EBITDA each year since 2009, across all markets, and all sizes and ages of MSPs. During that time, the Median has risen from 5.6% to 8.3%. Unfortunately, in any given year, one quarter of MSPs lose money.
This is true in your market. How do we know? We are by far the largest benchmarker of IT companies, and so we have benchmarking and/or consulting clients and/or peer group members just about everywhere. And, we've been in the business over 30 years. For the first 22, we operated IT companies from $50mm to $2bb, likely in your market.
Clearly, with one quarter of MSPs making good money, one quarter losing money, and the rest somewhere in between, in every market, the reasonable conclusion is that some MSP executives are formidable competitors, and some are not.
When you meet with IT company owners and executives, they probably seem to know the IT business better than you do. Don't they have some natural advantages in competing with you?
Yes, but you also have advantages over them, in the IT business.
The one advantage almost all of them have, is that they know IT technology. A large proportion of IT company owners and executives have technical backgrounds. They can talk expertly about IT technology.
This is enough to allow even those with the least business and leadership acumen and/or desires, to build a $1mm to perhaps $3mm local MSP business. There are many of these.
Unfortunately for those who wish to be bigger, technical acumen is only about one-fourth of what is needed to grow an IT business beyond that, and make good to great money in the process. Acumen is also needed in:
As with any other group of entrepreneurs, their natural capabilities in these vary widely, this explains the benchmark results in the chart above.
The IT business — at least that portion of it where most Copier Dealers are pursuing IT — is about where the automobile business was in, say, 1910. Back then, car dealers were small, and most car dealer owners weren't business people. They were "techies." They liked gasoline motors. They liked being automotive pioneers. They were enthusiastic and knowledgeable about the technology. Many – not all – went by the wayside when people with better business skills and higher financial goals, entered the business.
It's important to understand that the barrier to entry in the IT business is low. All you have to do is lose your job in an IT department, hang out your sign and start charging $50.00/hour. You will likely make more money in your first year than you did as an "IT guy" in some company. Your parents will probably think you are going to be the next Bill Gates. But, with all due respect, that's a far cry from building a sustainable, scaled business.
In our master database, we have over 36,000 IT companies. About one-third of those are, objectively speaking, materially in the Managed IT business. Nearly 85% are under $10mm in revenue; nearly 80% are under $5mm in revenue. Most of them have little formal business training or experience.
Don't get us wrong. These are our people. We love them. We help them accelerate, too. On average, they are getting larger. As you can see from the profitability chart, the Median are gradually getting more profitable. Even the Bottom Quartile are having fewer and lesser lows.
We mentioned you have some formidable advantages as well. They are:
To be sure, the Managed IT business isn't a cake-walk. It's hard work. For the most part, the least and most successful IT company owners and executives spend 110% of their waking hours keeping their companies on track and headed to the next level, just as you do. This is one reason we say, be sure your core business is at median performance or better, before you dive into the Managed IT business. This isn't a "toe in the water" thing. You'll lose your foot or your leg.
What are the real disadvantages in getting into the IT business? They're just as you would expect or may have by now deduced:
As always, the first step is to be aware of these disadvantages. For the prudent operator, these disadvantages are navigable. This is demonstrated by the increasing number of Copier Dealers who are increasingly successful in the IT business.
If adding a materially new line of business to a traditional sales force, were a new thing, one could forgive the fact there are too many consultants in this business giving bad advice about how to do it.
Let's get back to basics.
You'll recall from earlier in this newsletter, "OML" stands for Operational Maturity Level. We mean there are more efficient and effective ways of generating growth and profitability, as well as less efficient and effective ways to do so.
We measure OML across all the important aspects of the business. We know what the more successful folks do, and what the less successful folks do.
Given time, many of the less successful companies learn how to do things more like the more successful ones have learned to do.
Service Leadership's job, is to accelerate the speed with which you recognize where you are on the path, and, if you wish, to accelerate your progress by showing you the successful way. We can steer you around the pitfalls and blind alleys, providing reassurance (or cautions) along the way.
So, what are the OMLs of growing a new line of business when there is a traditional sales force and a traditional customer base?
We'll start with the presumption that your strategy is not to focus on winning new customers to your company as the primary way you will grow your IT business. However, you certainly should try to win new customers through IT (and then convert them to print customers). Hopefully you have not incorrectly concluded that your current copier base isn't a great place to sell Managed IT.
(And hopefully you have not incorrectly concluded that you should not risk doing so because your IT service quality isn't good – your IT service quality can and should be good. Hint: Enforcing your technology standards is the only proven path to quality and profit in the Managed IT business.)
Therefore, you wisely want to leverage your existing copier customer base to sell Managed IT.
What is the typical learning curve of organizations that accomplish this happy ending?
The usual first approach to selling a new line of business, like Managed IT, to the traditional customer base is the "common sense" one. This is to "train the copier reps on IT." This approach not only fails to drive IT sales, it often backfires because it negatively impacts revenue growth in your print business.
The reason it fails to drive IT growth isn't because copier reps aren't capable of learning how to sell IT. Most are – just like most (but not all) IT sales reps are capable of selling IT.
Here are the reasons why training the copier sales people to sell IT fails to drive IT revenue and profitability:
Meanwhile, the time spent out of the field being "trained on IT", and the copier reps' time budget for sales calls being increasingly consumed by "selling IT," they are spending less time selling print, and your print revenue growth backfires.
There are other, corollary outcomes which are only slightly less dire:
And similar poppycock.
All of this leads you to believe that, while others must be getting their copier reps to sell IT (they're not), your reps for whatever reason, are not able to do so.
Will your copier reps ever learn to sell Managed IT on their own? Yes. Once they have ridden shotgun on ten (10) closed Managed IT deals in their existing customer base, which have been properly sold in the high OML way. Only then will they be able to reasonably qualify, pitch and close a smaller Managed IT deal on their own. Eventually, they'll even learn how to successfully and safely sell bigger deals.
Do not let them try to sell any Managed IT deals, under any circumstances, until they have reached ten (10) closed managed IT deals the proper, high OML, way.
Anyone who advises you to train traditional reps to sell IT directly, has never successfully gotten a materially new line of business off the ground in a traditional business. Probably they have never even had the opportunity to try.
Once they have tried and failed with the low OML method, and correctly concluded their copier reps shouldn't be trained to sell Managed IT, many executives then decide to build a separate IT sales team:
This also seems like "common sense", and it works, for a time. Your IT sales will go up.
However, the more successfully this increases IT revenue, the more problems it creates. Within a meaningfully short period of time, those problems will become unmanageable to the extent that you will either "cap" IT revenue one way or the other, or you'll seek out the high OML way.
You might say, "Well, if IT revenue goes up, then whatever problems that creates are good problems to have."
Maybe. That is the winning entrepreneurial mantra, right? Then again, there are some problems not worth creating because the cost of solving them, and the risk if you don't solve them, are too high.
Two sales teams calling on one set of customers? Talk about cost. Talk about complexity for you and the customer. Talk about damaging your personal grief-to-profitability ratio.
Some executives work their way up through these OML levels. Some go right to the higher OML approach. Either one is fine with us, we're happy to help at any stage. We're always happy to see you be more successful sooner and with less investment and risk.
It is important to understand that the foremost objective at this stage of your Managed IT evolution — and forever — is that you deliver high quality service. Everything else is subordinate. The reason for this is, if you disappoint a customer, you then disappoint the rep. And if you disappoint the rep, they will never bring IT into another account. They will tell the other reps. Then, your ability to leverage your contract base, and even to sell to new customers, is dead in the water.
Service quality is everything. You know this, too, from your core business. Therefore, you must charge enough to be able to afford to deliver quality. Even if everything else that would allow you to deliver quality lines up — right Target Customer Profile, right technology stack, the whole bit — if you can't charge enough to be able to sustainably do a good job, don't close the deal.
Here is the sales model used by top performers to sell Managed IT through the copier reps to the contract base:
This is a high-level outline of the method used by the companies that successfully add Managed IT without risking damage to their copier revenue growth, and without incurring the cost and dissension that results from the "two sales forces" approach.
Obviously, the outline above is mostly "what to do", with a little "why" and an even smaller amount of "how." Not everything is free.
That said, if you do what the outline above instructs, you will have saved six to seven figures, and many fiscal quarters, and your grief-to-profitability ratio will make you smile sooner.
With all due respect, treat these instructions like my golf coach tells me to treat his instructions: "Stop thinking and just do what I tell you to do. You will shave strokes off your game and have more fun."
When is the last time you successfully added a materially new line of business?
We're not copier company experts, nor do we represent ourselves as being so. We are experts in helping copier companies succeed at adding Managed IT.
We've learned a bit of history about your business from you:
Your progression into selling Managed IT is the same, with some important exceptions:
So, you've likely used this model successfully before, in the color and digital transitions.
As have others. The high OML sales model also works for other companies in other traditional businesses who are trying to add Managed IT.
The first ever example is the original "Big Iron" company itself: IBM. In the early 1950's, IBM more or less invented the commercial computer business, with great success. Their sales team was the quintessential "big box" product sales model — heavy on quotas, aggressive management, massive "box" sales. You know the drill.
By the late 1970's it was becoming clear that just selling hardware wasn't going to cut it anymore, and that IBM needed to transition to adding services, including what would be called today, Managed IT. After some floundering around with current management, the board picked Louis Gerstner, CEO of RJR Nabisco, to take the helm at IBM.
Much to everyone's amazement, "Lou" from the cigarette-and-snacks company figured out the high OML sales model, and it worked. Meanwhile, a whole bunch of IBM's competition, tried either the low- or mid OML model and so didn't succeed soon enough. They either disappeared or become much smaller.
Other examples abound:
This isn't "our" model. It's the just the model we've used successfully in four companies. It's the one we've observed to have worked the best and quickest in the other companies who successfully added material new lines of business. It has helped most of our clients be successful and safe.
In late 2013, with GreatAmerica Financial Services, we formed the S-L GAMIT peer groups of Copier Dealers who are doing or who wanted to do IT. As part of their membership, we benchmark them quarterly — their entire company and their IT business within it.
The few larger ones who were already doing substantive IT at that time, were doing fairly well with it. They continue to do fairly well or better, albeit not without some of the challenges faced by some other IT companies.
The real question is, how are the Copier Dealers who when they joined had little or no IT, doing today? To answer this question, the data that follows purposefully excludes three large independent copier dealers who have been doing substantive IT all along, because we want to show you how the “newbies” and smaller ones are doing.
The year 2014 for these smaller Dealers was indeed a bloody one from an IT profitability standpoint:
In 2014, the Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) of their IT businesses — again leaving out the three "big guys" who had substantive and successful IT businesses — was negative 2,041%.
That large percentage — though obviously not good — should tell you that the actual dollar amount of the losses was relatively small as compared to their overall business. None went out of business because of it.
It should also tell you that they were, and most expected to be, in investment mode.
How, then, did the new-to-IT Copier Dealers do in 2015 and 2016?
The chart below shows the revenue mix and revenue growth of the average Copier Dealer doing IT (remember, we purposefully left out the "big three" so we can see how the newbies and the smaller ones are doing). The chart shows the eight quarters of 2015 and 2016.
The large light green segments of each bar, are the Managed IT revenue — the foundational purpose of these companies getting into Managed IT. As you can see, there is growth every quarter in this important line of IT business.
Along with that, you can see the expected growth of the blue segments — the IT equipment resales revenue. This has much lower value than the Managed IT revenue, but almost all Managed IT companies sell some equipment, because their Managed IT customers need it. The other revenue streams are common to Managed IT companies as well.
How similar is this revenue mix to that of what we might call "native" Managed IT companies, most often called within the industry, Managed Service Providers (or MSPs)?
The chart below shows the IT revenue mix of the Copier Dealers and the "native" MSPs with whom they compete.
The Copier Dealers have a higher proportion of equipment resale ("Non-Recur. Product", blue). As will be seen in a moment, this is likely due to their faster growth.
The Copier Dealers and the native MSPs have about the same proportion of revenue coming from Managed IT ("I26 Infra-MS", light green), though the MSPs have a higher proportion of installation services revenue ("I13 Infra-PS", mid-green) and of private cloud ("I21 I-SS" lightest green).
The difference in size of the installation services practices is material: About 10% of revenue is the right ratio. Copier Dealers are not installing as much of the equipment they are selling. Someone is either in-house IT people or other service providers. Or, they are needlessly giving away the implementation service at no cost.
We should note that, among "native" MSPs, the revenue ratios above are meaningfully different between the lowest-profit ones (who are losing money), the median profit ones and the top quartile profit ones (who are making 18% or better at the bottom line).
It isn't what you sell, as a Managed IT provider, as much as it is how you sell it, and how you deliver and manage it.
How well are these Copier Dealers growing their IT businesses as compared to the "native" MSPs with whom they compete?
The chart below shows the overall (far right pair of bars) and line-of-business revenue growth from 2015 to 2016. The Copier Dealers are shown in blue and the native MSPs are shown in gold.
As you can see, for the important lines of business (Managed IT, here labeled "I26 I-MS"), installation projects ("I13 I-PS") and equipment resale ("Non-Recur. Product"), the Copier Dealers are out-growing their native IT competitors, substantially:
One may wonder if the difference in growth might be because the IT businesses of the Copier Dealers are smaller than the native MSPs. This turns out not to be the case:
The difference in revenue growth is therefore not because the Copier dealers' IT business is materially smaller than that of the native MSPs. Why? See the "Advantages You Have" section starting on page 5.
If the Copier Dealers are making progress in Managed IT, their gross margin (GM) should be increasing as their revenue increases, in both dollar and percentage terms.
The chart below shows the gross margin by line of IT business and for the overall line of business, for the Copier Dealers in 2016 ("Most Recent 4 Quarters") and 2015 ("Previous 4 Quarters").
As you can see, their GM percentages (and because revenue is growing, their GM dollars), improved significantly. All the more so when you take into account that in 2014, many had negative gross margins in their IT services lines of business.
Their IT service GM rose by more than a third in 2016, to 29.4% from 21.7% in 2015. This number is important: To run a good IT services business requires spending about 30% of revenue on Sales, General and Administration (SG&A). That means the average Copier Dealer doing IT in 2016 was almost profitable at the bottom line. This is dramatic progress, as we shall see.
How does this compare to the native MSPs with whom they compete? The chart below tells us, for 2016.
The Copier Dealers had a GM of negative 14.7% in their applications services lines of business. For most, this is their document management solutions implementation services business. It is a small portion of their overall business. It can and should be profitable; we're happy to discuss how.
Some MSPs also have a small proportion of their revenue coming from applications services; this may be installing accounting software, or even document management solutions. They are running these very small lines of business at 38% GM.
Regarding the core business, the IT infrastructure services business, the Copier Dealers in 2016 averaged 29.4% GM – a big improvement over 2015, which itself was a huge improvement over 2014. The native MSPs, however, averaged over 51% GM. Since their businesses are not materially larger, how are they doing this? More on that in a moment.
The Copier Dealers are selling equipment at materially higher GMs: 28% versus 23% for the native MSPs. Why? Partially because Copier dealers understand financing, and partially because there is ingrained DNA in the IT business to "give equipment away." Their 23% is actually quite good; their brothers who mostly sell equipment and not much service, average about 11% GM on equipment.
Thus, the Copier Dealers' overall gross margin is 26% while the native MSPs are getting 39%. When we recall that it takes about 30% SG&A to run these businesses well, we see that the MSPs are, on average, profitable, while the Copier Dealers are not quite yet.
Why do the native MSPs get such higher gross margin on their IT services? Several reasons:
Copier Dealers have the "luxury", if you will, of making less money in the IT business, and presumably are sacrificing profitability for growth.
Given the differences in profitability (Copier Dealers are lower) and growth (Copier Dealers are higher), this evidently is what is happening.
If the best-in-class IT companies invest 30% of IT service revenue in SG&A, what are the Copier companies investing at this stage?
The chart below shows the Copier Dealers' spending on SG&A both as a percentage of their IT revenue, and also as a percentage of IT gross margin dollars.
We suggest this latter view because it is more helpful. You don't pay SG&A with revenue, you pay it with gross margin. The best-in-class IT companies spend about 65% of their gross margin dollars on SG&A.
What's left over, obviously, is operating income.
The chart above shows that, in 2015, the Copier Dealers spent about 44% of their IT revenue on SG&A related to their IT businesses.
In 2016, that number dropped to 32.6% of revenue, not far from the best-in-class number.
In 2015, the Copier Dealers spent about 195% of their IT gross margin dollars on their IT SG&A.
In 2016, that number dropped to 124% of gross margin dollars, a significant decline. This is still about double what the best in class IT companies spend (about 65%), and it is above what the average IT company spends (about 78%).
However, it is a big step in the right direction from 2015, which in itself was a big step ahead of 2014.
What, then, of bottom-line profitability?
Let us remind you again, that these results leave out the three largest independent Copier Dealers who are successfully doing IT. This is so we can see what is happening with the "newbies" and the Dealers who have smaller IT practices.
The chart below shows their progress in generating bottom line profitability in their IT businesses.
The Copier Dealers were not yet profitable in their IT businesses in 2016, but they're clearly getting there.
Note: If we added back in the three largest independents who are doing much more IT and who are profitable in IT, the average would in fact be profitable. Instead we want to show you the real story of the "newbies" and Dealers with smaller IT practices, not something masked by other Dealers' success in IT.
This is the improvement curve one would expect when investing in a new business headed for success.
In November 2016 and February of this year, we helped most of these Copier Dealers finalize their IT budgets for 2017. Happily, their ability to budget IT revenue and costs — what we call their "OML in budgeting" — has improved significantly over the last few years.
All of them have budgeted to be profitable in their IT businesses by the end of calendar 2017.
Good progress, indeed.
In helping them with their 2017 budgets, we encouraged them to be conservative on their sales volume budgets and to expect higher costs than most would like.
A characteristic of teams getting into new lines of business is that they start with optimism and what they often feel is a prudent level of caution. This would be 2014 for many Copier Dealers pursuing IT. We call this OML 1.
However, they don't know what they don't know, and so they often enter a period where the challenges and investment seem to mount, and the distance to the goal seems to extend. We call this the "pit of despair" or, more formally, OML 2. It isn't that the business gets harder, it's that they're discovering what's really involved. Many Copier Dealers were in this phase in 2015.
OML 3 is the stage at which enough of the basics are in place that tangible progress towards the goal is being made. The Copier Dealers — excluding the three largest independents who have had substantial IT businesses for many years — have not yet broken into profitability. They are, however, entering OML 3. They're on the improvement curve you'd expect to see in any new business unit on its way to success.
That success isn't guaranteed. Yet we hope not too many people are surprised that Copier Dealers are on the right path to success. There is nothing inherent in Copier Dealers that make them less likely to succeed in IT.
Unsurprisingly, as long as they combine the known best practices in strategy, sales and marketing, service, finance and compensation with motivation and energy, they, like everyone else who has done the same — including native IT companies — can attain best-in-class service quality, revenue growth, profitability and stock value in IT. We call this OML 4.
Service Leadership, Inc.
5800 Granite Parkway, Suite 460
Plano, TX 75024