Ten years ago I would have said multi-year managed services agreements were not only worth negotiating for, but I would also have said they were indispensable to creating value in your MSP practice. I still believe long term contracts have value, but I would like to amend my previous statements to include some alternative context to contract terms and MSP valuations.
MSP Valuations 101
Unlike companies such as factories, data centers, or retail stores, MSPs typically do not own physical assets. Physical assets like equipment, servers, etc., can be resold, liquidated, repossessed, leased, and other neat things that accountants like to do. All these assets mean higher value for the company in possession of them.
MSPs, on the other hand, tend to resell equipment, often acting as a pass-through entity when selling or leasing equipment being managed. After all, MSPs have traditionally not cared about the sale of the equipment, but instead, want the ongoing management revenue associated with the care of the asset. This is where the MSP’s value is.
Long Term Contracts
Back in the day (I like saying this phrase because it makes everything coming after it sounds wise), MSPs were taught that the longer the term of the agreement the more inherent value it had to the business. A three-year agreement was more valuable than a 1-year contract.
The practice of valuing MSPs according to the length of service contracts has been in use for many years. While it may have validated the objectives of MSP buyers, it may be time to re-imagine the value of having longer-term contracts with customers.
As more customers are asking for easier termination clauses, and cloud computing has added greater pressure through “as-a-service” offerings, lengthy MSP contracts may have seen their better years behind them.
Contract Term vs. Customer History
As with many things in managed services, our profession inherited a lot from the telecom and hosting industries; long-term contracts are one of those items. MSPs have always heard that the longer the term of the agreement the better. This thinking is still valid, to a degree.
Due to the lack of physical assets MSPs must demonstrate value in their business through other methods; agreement length is one of those ways. There have been periods in recent history where shorter-term agreements were promoted, even month-to-month service contracts were, at one time, believed to be the best model.
Regardless of the term of your agreements, there is another element we must not ignore, the length of time the customer has been with you. A new customer who just signed a multi-year agreement is less valuable than a 5-year customer who is on a monthly service agreement.
Customer retention is an undeniable factor when considering MSP valuation, and must not be discounted when compared to the length of a service contract. At the very least, customer retention must be part of the overall calculus of MSP valuations, side by side with agreement terms, the maturity of the MSP’s practice, vertical expertise, and many other elements having little or nothing to do with physical assets.
So, maybe it’s time for your MSP practice to take a closer look at your contract lengths and how they factor into your company’s value.