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Managed Service Contracts: Three Important Numbers

Managed Service Contracts are often viewed as the most attractive type of business within the ICT industry.  The reason for this is that the gross margins are typically high and relatively predictable.
I’ve outlined in the past why the attraction of gross margin is illusory – that’s outlined
But, it remains true that many business prioritise managed service business over other types of product.There are lots of problems that you will encounter when pricing a managed service though.  Here are some of the top issues I’ve encountered.

  1. There is usually a high cost of transition for the customer to make the switch from their existing supplier.  Your price has to be low enough to compensate both for the real costs of transition, AND the perceived risk to service implied in doing so
  2. Managed services require high levels of investment to develop the systems and capabilities required to deliver them. If you don’t believe me, check out the latest accounts from Outsourcery, a high profile cloud service provider.  Page 23 shows a gross margin of £1.9m on sales of £5.2m – a 36% margin.  But these are dwarfed by the £10m of administrative overheads (primarily associated with the cost of setting up the infrastructure and processes required to deliver the services).
  3. The trend in IT contracts over the last decade has been to progressively reduce the term of deals.  Where it was once routine for contracts to be let for 7, 9 or even 10 years, the new normal is for contract terms that are 3 years or less.  This gives you much less time over which to recover your investment.
When judging the right strategy for pricing a deal, you have to find the right balance between winning the business, vs. actually giving yourself a reasonable chance of a return on your investment. The problem is that most internal business cases will consider only the committed elements of a contract, not the “jam tomorrow” that is often promised by a hungry salesperson.
But, there is good news. In managed services, there is usually a considerable amount of jam to come…You need to think about the Three Important Numbers

  • Average contract length: 3 years
  • Average relationship length: 9 years
  • Average rate of additional business pa: 20-25% (not compounded, unfortunately!)

What this tells you is:

  • The business case for acquiring a managed service customer should recognise the fact that the relationship will (if you execute competently) run for significantly longer than the initial contract term. Price your bid accordingly
  • The money is almost always made on additional business that you are able to win during the life of the contract. Incentivise your account team and in-life service teams accordingly.