You may have heard that Penton Technology recently released the “new” MSP 501 list and survey for 2016.

One of the most exciting enhancements to the study this year was the inclusion of the Clarity Total Service Provider (TSP) Index developed by Clarity Channel Advisors. The Clarity TSP Index measures a company’s potential based on services revenue and productivity, measured by sales-per-employee. (This year, all MSP 501 companies were categorized into four TSP tiers—1, 2, 3 and 4, respectively.)

Since we revealed the MSP 501 and TSP Index, we have received a heap of praise and a lot of questions. The latter I want to address herein. Take a note I got from one leading MSP who made the 2016 MSP 501 list:

What I like about the new quality score is that it tries to take into account attributes that contribute to ‘health’ and ‘quality’ of revenue. I think that’s a good thing for the industry.

What I have an issue with is that revenue-per-employee (RPE) is a flawed characteristic in determining company ‘health.’ What happens if a company has 35 low-paid telemarketers or interns? It would make more sense to me to qualify RPE by let’s say ‘revenue-per-technical-employee.’ And, of course, since this number is not audited, folks can try to manipulate it next time around. Secondly, the RPE tends to favor a single delivery model, namely, fixed-fee arrangements. Some companies who are necessarily more labor dependent will be penalized for their choice of model and that doesn’t seem fair or accurate to me.

The other concern that I have regarding the MSP Mentor list is ranking 4 level MSPs higher than (some) 1, 2 or 3s. How does a level ‘4’ MSP, which, from your own words, means ‘least evolved,’ rank highest or among the highest on the 501 overall list?

Anyway, it’s a tough thing to try to rank players in such a competitive and dynamic industry and I’m glad that you folks are continuing to try.

Excellent questions. Here’s my response:

Thank you for reaching out and congratulations on ranking on the MSPmentor 501 list and for being recognized as a Tier 2 TSP. That’s quite an accomplishment! You obviously have done a great job building a healthy business focused on the right types of revenue.

In addition, thank you for appreciating the level of effort associated with collecting verified financial information, developing a new industry index and attempting to capture the health of this evolving market. As you know, there is no perfect formula that captures every aspect of this dynamic marketplace, especially when you consider the slight nuances of every different business. We did our best to focus on the general rules of the service provider market and not the exceptions. We also tried to highlight the types of revenue that promote better margins and long-term sustainability as the industry continues to change at a rapid rate.

You ask a number of good questions and bring up some insightful points. With respect to the RPE calculation, you can argue that if you have lower-paid employees dedicated to entry-level sales activities, then you should be able to get a higher return on those employees. That’s provided, of course, that they’re accomplishing their required tasks. In my experience it’s more difficult generating profitable returns on high-priced technical resources if you can’t keep them utilized at least 90 percent of the time. This is a challenge to achieve for 52 weeks per year if you don’t have an effective sales engine.  

Contractors, including 1099 resources, are also a factor. Based on polling, we found that service providers are as likely to use contractors for technical work as they are for low-level sales activities. For example, many MSPs use Onforce or Workmarket to leverage technical contractors for onsite work in areas where they don’t have W2 employee coverage. Also, a fair percentage MSPs outsource their help desk and NOC functions. To better understand the impact of 1099 resource usage, we asked about contractors in this year’s 501 survey. The results indicate that contractors don’t factor into the service provider equation as much as one might expect. In 2015, for example, only 7.3 percent of the MSPmentor 501 used 11 or more contractors somewhere within their operations. Nearly half didn’t use any contractors at all. Based on the low contractor impact, we decided not to include contractors in the Clarity TSP Index this year. That said, we will keep an eye on the trends and evolve the index metrics as necessary.

One other thing: It is 100 percent accurate that the TSP Index is biased against companies with “more labor dependent” business models, specifically models that leverage expensive engineers for tasks that can be automated. The TSP Index rewards companies that have figured out how to deliver recurring revenue (cloud, managed services) with automated tools and software packages that lower their total cost of labor, thus creating a more favorable RPE result. At the same time, the TSP Index rewards paid consulting visits (integrated into a managed services package or “virtual CIO” consultations) that drive greater value in a client relationship. This is because most of the solutions MSPs deliver are automated and remote and thus susceptible to the “out-of-sight, out-of-mind” challenge so many MSPs wrestle with.

We believe MSPs that augment their automated services with higher-value consultations performed by top-level employees who can “wow” customers every quarter deserve higher recognition.

There is little question that the service provider market is changing quickly. One reason? Margin pressure, which 70 percent of service providers feel in “moderate” to “high” levels, according to the MSPmentor 501 study. To combat this challenge and others, Clarity developed the TSP Index, which isolates the business and market factors that contribute to sustainable, long-term success. Clarity works with a number of Tier 3 and 4 TSPs that are strong businesses. They are run by intelligent leaders, many of whom have been around for over a decade and realize that a business model developed around products and services - circa 2007 - will not generate the same returns in 2017 and beyond.

Lastly, I want to address the reader’s final question: “How does a level ‘4’ MSP, which, from your own words, means ‘least evolved,’ rank highest or among the highest on the 501 overall list?” The Clarity TSP Index is an evolutionary score based on a company’s current business model and the types of revenue they’re driving (cloud, managed and consulting). One of the first lessons I learned when evaluating publicly traded stocks is that past performance does not guarantee future results.

In 2010, when I was working for Staples (my MSP, Thrive Networks, was acquired by Staples) the company generated net income of $1.23 billion, which gave it a market cap of nearly $18 billion.  At the time, Amazon’s net income was $1.2 billion. But it’s market cap was a whopping $58.1 billion. If you were to value the companies by looking at only their past results, you’d have to conclude that Staples  was the better stock. But as we all know, that wasn’t the case. The better stock play was the one with a more evolved approach to business. Today, Staples has a market cap of $5.6 billion while Amazon is worth $331 billion.

I believe the same principles hold true for MSPs. If the MSPmentor 501 consisted of all publicly traded companies, there would be a number companies that I would not invest in based on their poor TSP index score. In fact, if I were to choose to invest in a select few MSPs, I would start my due diligence by reconciling the MSPmentor 501 and the Clarity TSP Index Score to isolate the companies in the MSPmentor Top 50 that have either a Tier 1 or Tier 2 TSP rating. From there I would narrow the list further by looking at growth rates, management teams, sales models and product roadmaps.

Armed with both the MSP 501 ranking and the Clarity TSP Index, the market has a better way to identify the MSPs focused on the revenue drivers of tomorrow.