SCALING YOUR BUSINESS
How To Get A Handle
On The Single Biggest Profit Drain In Your MSP : Labor
By Greg Crabtree , CPA , Partner , Carr Riggs & Ingram LLC
Without the leveraging of labor , there is no profit made in an operating business . The MSP business model is one of the best at leveraging labor of all the industries my team consults with . An MSP that deploys a good labor strategy and effectively manages their team will achieve profit above the industry standard and an exceptional return on invested capital as well .
Strategy First
There are only two labor strategies in business :
• Flex your labor to what you sell to .
• Sell to the labor you commit to .
MSPs require highly skilled labor that is not easily found , so you will generally not be able to flex labor to what you sell to ; you must commit to your current team and sell work to make that team profitable . There is some possible flex in help desk functions and other specialized services , but that is carving off a segment of your sales and letting someone else be profitable at that activity . Your margin is only what you get to keep after subcontracting it out .
The first $ 1 million of gross margin ( revenue minus COGS , excluding labor ) is the first significant data point . It has been our experience that performance ratios tend to stabilize and scale after that point is reached . To get to that point and beyond , there are only two labor growth strategies :
• Stretch your team until they are “ running hot .”
• Hire labor needed for growth in advance , and push marketing and sales to get profitable .
Both of these growth strategies have their risks , and you are making a bet to stretch your team . To add labor in advance of growth can push your business into losing money and eat into your cash reserves or force you to borrow to support the growth . Being overstaffed at any point also takes the performance edge off teams , and they develop bad habits of not working with a sense of urgency . As you start to grow , the team cries for more help too soon since they are accustomed to a slower pace of work .
There is no doubt that businesses have been successful at both . However , if you have not demonstrated a history of consistent inbound leads that convert into new sales , advance hiring has the lowest possible chance of successful outcomes and will lead to reset of labor at some point and diminished reserves and lower profit distributions for the owners . If the owners require consistent profit distributions for consumption , or outside the business commitments , hiring in advance can lead to financial disaster if it fails to produce results quickly .
Using Labor Efficiency Ratio ( LER ) To Manage The Strategy
There are two key metrics to manage this process :
• Direct Labor Efficiency ( dLER ) — gross margin divided by direct labor
• Management Labor Efficiency ( mLER ) — contribution margin ( gross margin minus direct labor ) divided by management labor
( Note : For a more detailed discussion of LER and ROIC , see Chapters 1 and 8 in my book “ Simple Numbers 2.0 , Rules for Smart Scaling .”)
A couple of quick definitions — don ’ t overthink it ; just be consistent on who goes where , and if it is close , put them in direct labor .
• Direct labor is the gross wages of your client-facing team . It does not include payroll taxes , just gross wages . If you have an independent contractor who mostly works for you , it is fine to include them in direct labor . Do not
VOLUME 2 ISSUE 3 • MSPSuccessMagazine . com | 21