Why Recurring Revenue Profitability Relies On New Business

Why Recurring Revenue Profitability Relies On New Business

In a recent article, cloud and tech guru Todd Hussey explained the importance of understanding the Cost of Customer Acquisition (COC) when growing your IT services business in the next era of the cloud.

As cloud adoption rises, more and more providers have set their sights on a recurring revenue model. The "profitability" discussion around the cloud emphasizes the value of managed services over one-off projects. This naturally evokes a rally around retention efforts and maximizing customer lifetime value; but there’s a danger in too narrow a focus on your existing customer base. Many services providers overlook the importance—or as Todd explains, necessity—of acquiring new customers to remain profitable.

In the not-too-distant future, IT pros will need to rethink their business just to survive—let alone to become a Modern MSP.

growth recurring revenue

It starts with a shift in measuring success as defined by profitability. Todd explains:

"There are two kinds of profitability to consider: gross profit and net profit. Gross profit is simply the amount of money generated by your managed service fees after subtracting the cost of service delivery. Over the years, IT service providers (Modern MSPs didn't exist years ago) have spent a ton of time and effort maximizing their gross margins by wringing as much cost out of service delivery as possible. However, many make a big mistake: they believe that by maximizing their gross margins, they have maximized their profitability. The problem is that gross margin improvement is only half the battle.”

It makes sense that many IT shops are stuck thinking about profits in terms of margins. Prior to the cloud, margins have been the areas in which businesses capitalized on revenue with one-time projects and services—especially for smaller companies without packaged IP.

Now we're moving into an era where our historic model no longer sustains growth, and being "profitable" in the cloud relies on growing your business with new customers as much as establishing recurring revenue from managed services within your existing base.

Back to profitability and the other half of the battle. Todd continues:

"Net profits: the amount of money left over after you subtract all of your operating expenses from gross profit. Operating expenses include sales, marketing and administrative expenses and must be funded by gross margin dollars. Generating a high gross profit only to give it back with high operating expenses is an exercise in futility. If your business produces high gross margins but you are still unable to realize healthy net margins then you are probably suffering from a high cost of customer acquisition."


The fix? Time to modernize sales and marketing (or as some have called it: "smarketing").

A comprehensive and successful acquisition strategy requires a certain harmony between sales and marketing, specifically around a solid approach to lead generation. You have to consider cost per lead, lead conversion rates, and strategic pipeline management, the whole of which is "not a natural or intuitive process for most entrepreneurs who are cut from a technical bolt of cloth."

Although new customers are many times more expensive to acquire than maintaining an existing clientele, a paradigm shift in your business model just isn't possible without addressing your acquisition strategy—including a deeper understanding of the COC.

There’s much more to learn and consider, including how to formulate the Cost of Customer Acquisition and the building blocks of a comprehensive go-to-market strategy for a modern managed services business. Do yourself a favor and read Todd’s full article on ModernMSP.com.

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