What Most People Won’t Tell You About MSP Billing Models

You’ll often hear thought leadership pieces saying things like “as you move into managed services” or “as you begin to transition your base into AYCE agreements.”

You’re likely to find the same sentiments in your favorite MSP hangouts as well. It’s almost as though every MSP journey inevitably leads to the same place: a world with nothing but all-you-can-eat (AYCE) contracts.

The truth about MSP billing models is that wherever you’re seeing the most success is where you should focus your efforts. If Babe Ruth was told he couldn’t bat left-handed because 9 in 10 people playing the sport batted right-handed, I doubt we’d know his name at all.

If you’re signing extremely efficient (hence profitable) block-hour contracts, for example, you’re not going to magically start earning more by shifting efforts toward closing AYCE agreements instead. In fact, in many instances doing so can be the equivalent to slamming into a brick wall in terms of your upward mobility. I’ll get into why in a minute.

Contract terms, or contracts themselves for that matter, are a closing tool. Nothing more, nothing less. Understanding how to wield them, and more importantly, understanding when your specific MSP is ready to wield them, is equally as important as your technical acumen itself.

MSP billing model 1: Hourly work

Before we get into contracts, let’s talk about hourly work for a moment. Hourly work is the pariah of the MSP space. “Break-fix” is almost used as a pejorative term. You might have even heard MSPs going so far as to say if you have any semblance of hourly work you’re quite simply not an MSP at all.

My MSP at its height did over a million dollars in break-fix labor revenue alone. I never once wondered if I was an MSP.

My MSP did, however, perpetuate the myth that “real” MSPs don’t touch break-fix work for one reason and one reason only: because it worked to our advantage. It kept MSPs in our service regions out of hourly work, increasing both our closure rates and our hourly rates at the same time.

I’m not an MSP anymore, which means you’re not my competition anymore. So I have no qualms about pulling back the curtain and revealing what lies behind. For those of you that already know what I know here, apologies. You’re about to have some stiff competition for the first time in a long time.

Hourly work feeds managed services contracts

An hourly MSP billing model isn’t something you should ever intend to grow out of. It forms a perfect symbiotic relationship between the managed services world and the break-fix world. The only way to achieve the upper echelons of your labor revenue per full time employee is by understanding how to leverage all work types to your advantage.

For example, over 40% of my managed services contracts came from referrals on the break-fix side of the house. In fact, we’d often use project work as leverage into migrating customers onto managed services contracts by design.

Imagine a small office that calls you out to replace a failing server and do some network upgrades. Maybe the bill totals $1,000 in labor. You could certainly bill this customer for a thousand bucks and call it a day. Or, you could view this as a far larger opportunity.

If you were to sign this customer under a managed services agreement for say, $500 a month, after just three years this customer’s potential value shifts from $1,000 to $18,000.

Using your project work as a lure, you can tell the customer you can bill them the thousand dollars—or you can maintain their environment indefinitely for a small monthly fee and they’ll never be out of business again like they’d been while your work was underway.

Offer to roll the $1,000 of work into the first month’s service. Now they’re looking at a managed services contract with two months free out of the gate. Think about that for a second. You just solved a huge pain point for this customer. You’ll likely never be in a better position to close a deal like this than you are right now. Most importantly, there’s an urgency to signing the contract because they physically owe you money. No one asks to go think about it for a month under these auspices.

We saw extraordinary closure rates using this method. In the event they didn’t sign with us, we happily left with our $1,000. If you asked me if I’d risk $1,000 to close a potential prospect with a lifetime value of $18,000 or more, I’d tell you I’d risk five times that without even thinking about it.

Hourly work is a low-liability proving ground

Besides being one of the best lures into managed services contracts out there, the break-fix world is one of the best low-liability proving grounds you could ever encounter.

When you’re hiring your next tech, or even hiring your first tech, the last thing you want to do is unleash them on your largest and most profitable clients. Use the break-fix work as a trial run. If things go south, you lose one or two hourly clients instead of one of your golden geese generating a large chunk of your monthly recurring revenue.

Not only is this a valid test against how well any individual does interacting with actual humans, but it also serves as a competency check as well.

Lots of folks interview well and are “proficient” in any number of things, at least as far as their resume is concerned. Sometimes something won’t present itself until they’re facing real-world problems, and the last thing you want them to do is inadvertently take your best client out of business due to a rookie mistake because you misinterpreted their general competency. Starting them on hourly work ensures that will never happen.

Don’t overlook residential… but pick your targets carefully

The last thing I’d like to discuss in regard to hourly work is that not all hourly work is created equal, particularly in the residential space, and this is precisely why this type of work gets such a shitty rap. If you aren’t targeting the right customer, is it any surprise they expect the world and don’t want to pay for it?

Look at the size of the houses you or your techs are walking into. Look at the cars in the driveway. Did you have to sign in with a guard before entering the community? Did the customer even review the invoice before handing over payment?

I think you can see where I’m going here. If you aren’t going to where the money is, the money certainly isn’t going to come to you. It’s that simple. Don’t let hourly work become a self-fulling prophecy, because there’s massive upside for those with the wherewithal to capitalize on it.

MSP billing model 2: Block-hour contracts

Block-hour contracts are a growing MSP’s best friend. They’re one of the most underutilized and misunderstood tools in the space. That’s because this type of contract is often conflated with selling a block of hours to a customer at some type of discount. While they sound the same, they’re really not.

The difference between block-hour contracts and a block of hours

Block-hour agreements are a bridge between hourly work and AYCE agreements. They’re not the equivalent of having someone prepay for a handful of hours at a discount. That’s a different term, one better known as leaving money on the table.

The difference is this. Block-hour contracts are designed to work within the confines of any given month. Meaning if you estimate what you expect a prospect will consume in time in any given month throughout the course of a year, this is what their contract represents.

It also means that if hours remain unused, they expire at the end of the month and the time block is refreshed to its original value for the following month.

Block-hour contracts also come with an overage clause, meaning if the customer exceeds their allotment of hours in any given month, they’ll pay an hourly rate for the difference. These hours are typically offered at an even heftier discount than the block hours themselves.

These terms are designed to protect both parties. If all hell breaks loose one month the customer doesn’t want to get whacked over the head with some insane bill. On the flip side, the MSP is protected in knowing that under the same circumstances, they aren’t expected to do all of the work for free like they would be under a traditional AYCE agreement.

So let’s say your hourly rate is $125 an hour for business clients. You may offer up a 10-hour-per-month contract at a rate of $1,000, or $100 an hour. That’s a decent discount for the promise of sticking around for at least the next 12 months.

Secondarily, you might say something like every hour over 10 in any given month will be billed at a rate of $60. This is less than half your hourly rate, and a significant discount off of your block-hour rates as well. You can refine these numbers to whatever best fits your business, but that’s the gist.

Selling block hours without a contract is a mistake

So does that mean those out there that are selling blocks on non-expirable hours are making a mistake? Actually, it means exactly that. When I said it leaves money on the table here’s why.

If you have a customer that wants to buy 10 hours of work at a discount, then they’re telling you that A) they like what you’re offering and B) they assume they’ll be consuming at least 10 hours of your time in the future.

If they already like what you’re selling, and they expect to consume the time they’re asking for, why are you offering it to them at a discount? Wouldn’t you make more by just allowing them to come to you each month and taking care of their needs as they come about?

You should never confuse that scenario with a real contract, because it’s not. They just paid you up front for work they were going to call you out to perform regardless, and they got you to offer it to them at a discount.

There’s a notion in the space that you have to “lock in” clients in some way, but why? Are you that worried about someone snaking your customer out from underneath you? If you are, there are likely other issues going on at your MSP.

If your customer was to go out of business you lose them anyway, so don’t get caught in this weird in-between area of prepay hours that aren’t under contract. It’s a derivation of break-fix that simply auctions off your hours for less than what they’re worth.

No contract also means you constantly have to go back to the customer to have additional hours approved each time the block is fully consumed. Or even before they’re consumed to avoid situations where the customer is “hard down” and you’re waiting for checks to clear. That’s not how to run an efficient and profitable MSP.

Block-hour contracts give you negotiating leverage

There are a multitude of benefits to block-hour contracts as an MSP billing model. One of the biggest is that you’ll never have more negotiating leverage than you do here. That’s because you can effectively increase contract value at virtually no cost to your MSP. This is true for two reasons.

The first reason: If you expect the customer to consume 10 hours of work a month, then you’d of course set up a block-hour contract that includes 10 hours of service. Once you get better at qualifying your prospects, however, you can showcase value that makes your contract more appealing, particularly when comparing it on paper vs competitors, while in reality costing you nothing. If your normal rate is $125 an hour, and you’re pitching this contract at $1,000, any reasonable person would run some quick napkin math and figure out they’re paying $100 an hour, and receiving a discount of $250 in aggregate.

If you know that the likelihood of them consuming more than 10 hours in any given month is say 1 in 100, then any number above 10 is still 10 as far as your business is concerned. It could be 11, or it could be 100, who cares? It will never be consumed.

The difference is that the same napkin math is now perceived differently. For example, at 15 hours under the same pricing, the customer would now be paying roughly $67 an hour for service, and saving a whopping $870 in aggregate. You, on the other hand, are still consuming 10 hours just like you expected.

Adjusting your top-end allocation of block hours should be considered your nuclear option. Use this when you aren’t confident in a close or you’re sure you’re bidding against multiple (legit) MSPs where you’re all vying for the top of the stack of bids.

The second reason is more nuanced and refined, and that’s adjusting your rate for your overage hours instead. Again, if it’s a 1 in 100 chance they would need to dip into this, you can sell them for a dollar and it still wouldn’t matter, at least not enough to change your profitability trajectory.

So if you’re maybe 85 – 90% confident in a closure and you feel the need to sweeten the deal to all but guarantee it, or the prospect just wants “something” to feel like they negotiated a better deal, look no further. Cut the overage rate by a third (or by half if you feel it’s warranted). It’s giving a discount on something they’re unlikely to ever experience, and you just guaranteed yourself a signed contract in the process.

Even if you misqualified your customer and they have say a 1 in 12 chance of using those extra five hours you added to their block-hour contract versus the 1 in 100 you originally assumed, just do the math. If that happens once a year for five hours you’ve suffered a total loss of $500. That means the $12,000 you’d be earning annually drops to $11,500. That’s only a 4% drop, and that’s only if you misqualified them in the first place.

These are pricing and negotiating tools you simply don’t have in your arsenal with AYCE contracts, which is what makes this style of contract so damn effective.

MSP billing model 3: All you can eat (AYCE) contracts

All-you-can-eat contracts effectively mean whatever your customer needs, your MSP is providing it for one fixed price.

You may have some reasonable exceptions to that. For example, you aren’t likely to be on the hook for trenching a new data line through their parking lot. You also might not be expected to get up at 3 am and be onsite within an hour. Then again, you may.

It all depends on how you have your SLAs defined. Traditionally, though, if something breaks, you’re going to be there fixing it no matter if it’s the first time or the hundredth time, and your contract rate remains identical.

AYCE contracts aren’t the end game

Now just because I said block-hour contracts are a bridge between break-fix and AYCE contracts, doesn’t mean you’re traveling one-way toward the ultimate goal of AYCE. You’re not.

In fact, the vast majority of your revenue should be derived from block-hour contracts, not AYCE, at least until you’re approaching somewhere around seven or eight employees.

That’s because when you’re just getting started, you likely suck at what’s called customer qualification. This is a skill much like negotiation, where you can only improve with experience, and any advice I or anyone else could offer here would only aid you marginally at best in the grand scheme of things. Simply put, there are no shortcuts to getting better at customer qualification.

AYCE contracts can be dangerous

One of the reasons all-you-can-eat contracts can be so dangerous, especially when signing multi-year contracts, is that if you massively misqualify a customer there isn’t much you can do to improve things until that contract expires.

For example, if you take a $1,000 a month AYCE contract and you’re only consuming 1 hour a month on average, congratulations that contract is earning you $1,000 an hour! On the flipside, if that same contract is consuming 25 hours a month, then you have my sympathies, because that contract is only earning you $40 an hour.

That’s the real danger here. What can you do if you’re so far off that you signed a three-year contract at what amounts to $40 an hour? Hell, what do you do if you signed that for one year? It means you’ve now shaved off a percentage of your only true asset as an MSP, your time, and you sold it for peanuts.

This now gets averaged into every other contract you sign, dragging down your entire MSP and your ability to grow right along with it.

AYCE contracts bring more liability

The other reason AYCE contracts are often so dangerous is that the pricing that goes along with this type of contract isn’t something that your run-of-the-mill office is going to be able to afford, or at least have the desire to pay.

So when you start getting into a class of customer that can pay, you need to remind yourself that this class of customer is not the same as the class of customer you’ve been dealing with up until this point. They’re generating far more revenue, which means you’re taking on far more liability, and their expectations skyrocket as a result. Experience in customer qualification matters here, and jumping in head first often leads to disastrous results.

So if it’s such a huge risk to take on, why does anyone bother going after AYCE at all? Well, where there’s risk, there’s reward, and there is a hell of a lot of reward to be had.

AYCE can bring big rewards

Because AYCE-style contracts typically only live within the confines of much larger customers, your skillset in automation can truly come into play here.

Oftentimes when you pick up an AYCE-qualified customer, they’re going to be in some manner of disarray. When a five-user office is in disarray, that can be stressful enough. When a 50 or 100-person office is in disarray, that can be a downright nightmare out of the gate.

You’re likely to qualify them with the nightmare scenario at play, meaning once you get things under control not only will your hourly commitment each month decline, but once you shift from damage control to automation and process improvement you can really buy back some of those consumed ours through some cleverly customized automations.

So where you may have initially qualified the customer at say, 40 hours of work a month, six months in you may only be consuming 25 or fewer. That’s when you can begin reselling those sold hours again because they aren’t being consumed, and where you’ll find the largest jump in your labor revenue per full time employee.

However, treat AYCE with the respect it deserves. If you fly too close to the sun with too many of them in tow, and everything goes wrong at the same time, you’ll find yourself undermanned, breaching contract SLAs left and right, and quite possibly wind up damaging your reputation and making it all but impossible to continue moving into those upmarket clients.

Properly balancing your risk is the key to not just rapid MSP growth, but sustainable MSP growth. Being the fastest at takeoff doesn’t mean jack if you explode midair. Never forget that.

A final word on MSP billing models

The most important thing I hope you all take from this article is that you should never let someone else sell you into, or out of, something that’s working for you. It’s always important to know where others are seeing success and why, but it’s equally as important to understand where your personal strengths lie at any given moment.

To grow your MSP you’re likely going to have to move into arenas that make you uncomfortable, and that’s okay. Just make sure when you do you’re properly prepared by understanding the true value of each side of the coin.

The one thing I will say is that one of the stupidest things any MSP can do is wave goodbye to real money because they feel it’s beneath them, or that they’ve grown to a point where they’re no longer needed.

Properly balancing all three MSP billing models is the key to maximizing your potential as a service provider, and maximizing your labor revenue per FTE right along with it.

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Looking for more insights from Andy on pricing and packaging your managed services? Download your free copy of The Profitable MSP Guide to Pricing Managed Services.