By Gillis Cashman, Managing Partner
It’s easy to get caught up in the hype cycles of bleeding edge tech, but often it’s the stalwart sectors that provide the most meaningful market opportunities. Due to a confluence of macro trends in communications and IT, there’s one such sector that’s experiencing unprecedented demand and generating substantial value: Managed Service Providers (MSPs)
As digital transformation becomes table stakes and nearly everything moves to the cloud, organizations are struggling to manage their complex IT needs internally. Gone are the days of underlying infrastructure and applications residing in one easy-to-manage location. With over 90% of enterprises employing a multi-cloud strategy, today’s IT teams have to grapple with highly distributed environments. And these increasingly decentralized environments are proving difficult to secure: Software vulnerabilities were up nearly 60% last year and cyberattacks increased by nearly 40%, reaching an all-time high of almost 1,200 weekly attacks per organizations in Q4‘22.
Adding to the challenge, most organizations don’t have sufficient, in-house IT staff to manage their complex environments. CIOs are losing their most talented IT employees faster than they can hire, with 86% reporting they’re facing more competition for qualified candidates and 73% concerned about IT talent attrition. In fact, with IT services spending growing faster than internal services in every industry, many of those talented IT employees are leaving the enterprise landscape for MSPs that can better satisfy increased wage requirements, development opportunities and career prospects.
Opportunities Abound for Infrastructure and Vertical-Focused MSPs
From a founder and CEO perspective, the MSP sector is rife with opportunity. With stable, recurring revenue contracts and strong unit economics, MSP business models are well-equipped to consistently generate value — even during periods of economic volatility. And MSP offerings can be continuously differentiated by investing in not just products or services, but also in delivery platform and scalability.
With the least amount of in-house IT resources, small and medium-sized enterprises (SMEs) are the fastest growing segment of the MSP sector. As software, tools and processes continue to be developed to integrate, productize and automate a broad suite of services at a reasonable price, more SMEs are embracing fully managed IT services in lieu of disparate point solutions. Still, the MSP market remains highly fragmented and there remains a massive consolidation opportunity to build regional and super-regional scale. With SMEs requiring increasingly sophisticated offerings to manage their complex IT needs, scale is becoming critically important to fund required investments in product, sales and service delivery.
For infrastructure-focused MSPs, which provide specialty services for various verticals, regional density is key for long-term success. SMEs value local relationships, so MSPs that can attract the strongest sales, delivery and support talent at the local level can build real competitive differentiation. Vertically-focused MSPs, on the other hand, require specialization either around a specific application or compliance framework. In highly regulated or specialized verticals, the barrier to entry for any MSP involves establishing and maintaining a deeply focused skillset and service delivery framework.
Operational and Integration Discipline is Essential for MSP Scalability
As the leading private equity investor for consolidating and scaling MSPs (35 acquisitions and counting), we’ve recognized clear patterns for success in the sector. Revenue retention, organic growth, a healthy margin profile, cross-selling opportunities, a breadth of services mix and an end-market focus are all crucial characteristics, however the most important value driver for any MSP is operational and integration discipline.
Certainly, MSPs need to determine how they’re going to deliver and sell their services, and support customers. But even more important is determining how they’re going to integrate their services set, delivery methodology and support processes to ensure seamless continuity across regions and customers. Applying this kind of operational and integration discipline isn’t easy and will inevitably result in some initial customer churn, but it’s critical. Because if MSPs fail to unify each new service, contract and delivery method, achieving any efficiency of scale becomes impossible.
Best Practices for Successfully Building and Scaling MSPs
When working to build and scale an infrastructure or vertical-focused MSP, we’ve found these six best practices most helpful:
- Expanding service offerings through the development of additional next-gen managed services, such as cybersecurity, hybrid cloud management, compliance and application managed services
- Establishing a capable sales team and nurturing channel partners, while also building a sales commission structure that incentives higher margin recurring revenue and long-term contracts
- Optimizing service delivery organization structure to drive better delivery efficiency and support scalability
- Driving automation at the delivery and service desk teams, and introducing customer self-service capabilities
- Productizing offerings further by creating a catalog of services with defined scope, process for pricing, delivery and support
- Leveraging best of breed IT service management tools (e.g., ServiceNow) to drive improved customer service, automation and visibility
Real World Examples of Driving MSP Growth and Value Creation
We’ve had the privilege of partnering with dozens of MSPs to accelerate their businesses and drive value creation. In 2016, we partnered with CEO Rob Stephenson and established Thrive, an MSP acquisition platform and leading provider of next generation managed services in the Northeast. Our acquisition strategy focused less on driving cost synergies, and more on adding product capabilities and management talent. This enabled Thrive to accelerate growth in sales and invest in delivery, which ultimately drove industry-leading organic growth and margins. We’ve since applied this impactful regional growth strategy to Ascend Technologies in the Midwest, and Edafio in the South and Southwest.
In 2022, we merged C3 and Steel Root to form C3 Integrated Solutions, a vertical-focused MSP that provides managed compliance and IT services to customers in the Defense Industrial Base (DIB). We’d recognized that a specific segment of the DIB needed a specialized technology stack and delivery architecture to meet the complex Cybersecurity Maturity Model Certification (CMMC) requirements. Given the highly specialized nature of this customer need, and our perspective from our other MSP portfolio companies, we knew more generalist MSPs would struggle to address this market. C3’s industry-leading CMMC Reference Architecture is a clear differentiator that enables an easy-to-deploy, comprehensive and fully-managed compliance services offering. Recruiting strong technical and sales talent has been key for cementing the company’s market position and vision, and the cross-selling potential across its customer base is already high.
Investing in the Integrated Delivery of MSP Offerings is Paramount
Market demand for MSPs stands to increase even further in the coming years. With government-mandated compliance becoming a more urgent issue for highly regulated industries like healthcare, defense and financial services, MSPs that provide specialization in these sectors will likely experience the most rapid growth. Providing a full product set to address the needs of customers is key for any MSP, but investing in the delivery of that product set will be the ultimate competitive differentiator. Resources for building out all the necessary sales channels are already exceedingly hard to come by, so investing in an integrated delivery platform with capabilities like automation is paramount for driving pricing efficiency and long-term scalability.
About the Author
Gillis Cashman has been a member of the M/C Partners team for more than 20 years, participating in every facet of the business, including fundraising, portfolio management and building the M/C Partners leadership team. He currently serves on the Board of Ascend Technologies, C3 Integrated Solutions, Carbon60, celito.net, DAS42, Denovo, Edafio Technology Partners and Thrive Networks. Previous Board seats include: Baja Broadband, Cavalier Telephone, City Signal Communication, CSDVRS, Elantic Networks, Ensono, Everstream, FDN Networks, Involta, MCCC ICG Holdings, Onvoy, PlumChoice, QOS Networks and Zayo Group. Prior to M/C Partners, Gillis worked on mergers and acquisitions in the Global Telecommunications Corporate Finance Group at Salomon Smith Barney. Gillis graduated cum laude from Duke University where he received an B.A. in Economics with distinction.