Justin Woodbridge

I spent the last few months researching and talking to many owners and operators in the IT MSP space, and figured it would be helpful to me and interesting to others to work through and structure all my notes on the market.

Before I get into it - why am I even looking at MSPs? My directional goal has been finding opportunities for better back office automation (that has now evolved, in part through this research work, into a more clear thesis around services and software).

Initially, I got the idea to look at MSPs and IT services generally from my friend Josh (founder of Zipsec, which does security and management work in lieu of a working with an MSP. Conversations with Josh in general have been quite informative in exploring the market.)

The 3 main reasons why I took the time to dig into MSPs:

1. It’s a strong business model (which I’ll expand more on as we go here) - B2B, sticky, recurring.
2. Regardless of how AI continues to evolve, with the current progress of models it feels very likely that demand SMB/trad business demand for assistance/guidance in deploying the tech will continue to grow, keeping a solid floor on current IT service demand and creating strong growth.
3. MSPs form a dense / powerful distribution network to sell into hundreds of thousands of managed devices and users. MSP people call it “The Channel”.

I’m going to split these notes into a sequence of posts. For this first one, I’m going to cover the basics: what MSPs do, how the model works, who they serve, and my thoughts on the market quality to sell products and services to.

I’ll follow up with separate essays on the history of the space from a software perspective, the dynamics at play with PE/rollup consolidation, past SV startup attempts to play in the market, and a longer-form discussion of MSPs as a distribution network (“The Channel”).

MSP Basics

Very briefly, what are MSPs? A theme that will continue to pop up throughout this is that nailing down what a classic “MSP” looks like is actually quite hard, and working against an idealized “Managed Service Provider” with a bunch of reliable shared traits, operational habits, business model, etc. is somewhat misleading. But let’s get into it, and we’ll expand more on that as we go.

What does the IT Managed Service Provider do?

MSPs are outsourced service providers - they are dedicated firms that other businesses contract with to outsource their internal IT, which means things like:

• User support / help desk –> helping staff figure out how to do things on their computer.
• User onboarding / off boarding
• Network management, infrastructure, email
• Some cybersecurity (though this varies substantially, and there’s an dedicated class of Managed Security Service Providers (MSSPs))

More and more, firms are starting to offer higher level strategic consulting services on top of the basic (increasingly commodified) technical work. This looks like offering IT roadmapping, planning, etc (fractional / virtual CIO work), and cybersecurity roadmapping and planning (fractional / virtual CISO work)

They’re cheaper than having a full time staff onboard, and bring dedicated knowledge, comparative advantage, etc: the standard arguments for this kind of outsourcing.

Of course what these abstract model looks like in practice varies significantly (which, as we will get to, makes this a tough market to address).

The Business Model

The classic model IT firm model was break-fix, where service fees are billed as the client needs work done. This was most prevalent in the 90s, as smaller independent IT consulting firms began to pop up. This model skewed reactive - dealing with issues as they popped up.

Into the 2000s, the model shifted towards more proactive managed work on flat-fee, all-inclusive service contracts, with the idea being MSPs could focus on preventing issues rather than just fixing them¹.

This is the contemporary “idealized” model: recurring subscription revenue, typically billed per staff-member of the end customer organization, eg $200/month for each of your 5 staff. Typically (but not always), this covers all the service provided by the MSP. Some MSPs bill extra for projects above a certain complexity, or individual support tickets above a certain number of hours.

On top of that, many MSPs act as resellers, setting up and managing services like Office365 and other big 3 cloud services, billing it out at a marked up rate to the client, and collecting the difference (“Value-Added Reselling”, “VAR”). Sometimes they also resell hardware at a markup as well, though this is decreasing in practice and the margins are pretty small. This is a preview of what is one of the most interesting aspects of the market - MSPs as a distribution channel into the long-tail of SMBs. It’s such a potent force that it has its own slang in the industry - “The Channel”. I will cover more on this later - but the key idea is that MSPs not just act as a doorway into MSPs, but also as advisors/support and implementation specialists for the software.

The model keeps evolving as people look for additional revenue streams - two of the most recent trends have been adding in cloud migration and cloud management work, and particularly in recent years, managed security services. Security in particular is typically high margin, and still a source of differentiation against other MSPs

Who do they serve?

If we want to talk about the classic MSP, it’s worth picturing a regional-focused business that specializes in serving their local area. They contract with the trad businesses like law firms, non-profits, real estate, account firms, manufacturing, etc. Basically an non digitally-native business.

Some MSPs focus on a particular vertical, but the typical MSPs stays horizontal and regional. Some do co-managed IT, where they work with an in-house provider in tandem.

The Ecosystem

There are about 40,000 MSPs in the United States, and about 100k+ globally. The exact number is hard to pin down - and many of the numbers floating around all trace back to a few blog posts by ConnectWise (one of the main software vendors, which I will cover in the software landscape post).

Part of what makes quantifying the hard is how to define what an MSP is - because the exact breakdown in terms of revenue type, from one-off projects, to recurring managed service revenue, to re-selling markup, varies. Is it an MSP if they only do 20% of the revenue off contracted recurring managed service spend?

The distribution of success of these businesses is pretty brutal - 31% of them are not profitable. On the other side of the curve, of course, are really big ones, hitting multiple 8-figures of revenue. ChannelFutures puts out a report of the top 501 MSPs based on their survey data which illustrates this:

1. MSP 501 aggregate revenue: $24.9 billion
2. Average revenue Per MSP 501: $49.6 million; median: $6.8 million
3. Average total recurring revenue from managed services: $23 million; median: $4.5 million.

So talking about an average “MSP” is actually quite challenging. It’s worth breaking down the market into a few main segments:

SMB

• These are the small scale providers, they are typically sub $1m of revenue.
• On this end, you can think of them almost like a traditional blue collar service business (plumber, HVAC). Often times, a tech will go off on his or her own and start up a shop. They’ll get contracts, and then bring on a few more people to help them.
• They are not operationally sophisticated and they are frequently unprofitable.
• They have few repeatable playbooks and most work is undocumented
• This is the most common archetype of MSP.

LMM/Scaled

• Roughly, starting at the $3-5m of revenue range, and can scale into multi-8-figures.
• These are the shops that have figured out how to standardize their operations (internally for client service, for hiring techs, and bringing on new business).
• MSPs at this scale start to have real management outside the owners / partners.
• It’s unclear how many MSPs exist at this range / operationally maturity level. It’s likely < 2000.

PE Platform / Rollups / Holding Companies

• Given the stickiness of MSP service contracts (very high switching costs, and long-term commitments at the contract level (2-3 year)), MSPs have been bid up substantially by outside investors. Multiples are now very high (6 to 10x earnings for ones at scale).
  • It’s also common for MSPs to consolidate other smaller MSPs, either for their entire company, or just trading around books of businesses.
• There are many PE platform companies, in addition to dedicated holding companies like Lyra (decentralized holding company) and New Charter.
• Naturally, the model has been attractive to MBA search fund types as well.
• I’m going to discuss this in more detail in a dedicated post about the history of the market from a startup / tech perspective.

Evaluating the Market

That’s the high level summary of how this space works, from having dozens of conversations with owners and investors in the past few months. So what do I think about selling into MSPs? Is it worth building products for?

The good:

1. The pure-play MSP selling locked-in managed services has a very good business model:
   1. Selling to B2B customers
   2. It’s recurring, highly sticky revenue, with very tight lock in.
   3. Revenue growth is structurally baked in in the model: as the end-companies grow, the MSP adds on more and more staff under management each year.
   4. In theory, this means their stable, predictable revenues should translate into comfort buying tools and services to assist in handling their contracts.
2. The market is relatively underserved in traditional SV tech (which I’ll expand on in my subsequent post about the software ecosystem).
3. MSPs represent an incredibly dense network of relationships into the long-tail of SMBs, which is expensive and time consuming to reach. Selling to MSPs, and then re-selling to individual users, is the holy grail and why cybersecurity SaaS businesses can be massive.
   1. Anecdotally, this is the strategic insight that has come up again and again as I’ve talked to other founders building software for MSPs: MSPs are hard to sell to, don’t have a ton of money, and the “shape of an MSP” varies so much. But: selling through MSPs, where you are giving them a revenue stream, works, and works well.
4. MSPs can be a foothold into the broader IT services market, which is huge, and has larger, more coherent buyers (scaled internal IT).

Neutral

• It is highly in-person, community driven. There is a distinct culture of conferences, peer support groups (Service Leadership run by ConnectWise), and an atypically densely connected graph of people working in the industry. From conversations with other founders, this means that breaking in to the ingroup can be hard, but once you pass the threshold, word of mouth can take you far.

The bad

• It’s a relatively small market (40,000 MSPs) in the US, many of which are very small, and not profitable.
• What an MSP look like can vary so much, that having a clear ICP of MSP is challenging. Coupled with an already relatively small TAM, it’s tougher to really have a clear picture of how many MSPs that fit your desired profile there really are. That’s not to mention the challenge of designing a standard product / service offering for a relatively hazy target.
  • Selling to an MSP owner/operator run MSP is very different than selling to the >$5m range with a management team.
• It’s a technical market, which anecdotally reminds me of some of the main warnings against selling to developers: they are picky and they think they can create solutions themselves

My conclusion?

1. MSPs are probably a good initial wedge market, if you are building a IT/Cybersecurity product.
2. If your product can be re-sold through MSPs (“The Channel”), then it is an incredible opportunity and continues to feel under discussed by SV tech as a strategy.
3. MSPs shouldn’t be the only market you sell to, just the beachhead - it’s not big enough to justify the focus, and the lack of a clear, “platonic MSP” makes designing a standard offering challenging.

Next up, I’m going to write about the history of the market from a software perspective - both tools for MSPs (RMMs, PSAs), startups trying to replace MSPs (Electric AI), the current dynamics of PE consolidation and the latest trend of looking for industries to rollup and deploy AI tech into (MSPs from the tech-enabled service perspective)