Consolidation in the MSP market: the end of the Channel as we know it?
The past year has seen high levels of M&A activity in the IT channel – and a prediction that 20 percent of MSPs will dominate 80 percent of managed services revenue in the U.S. by 2020.
What is fuelling this activity? Is it really happening at an unprecedented level? And what does it mean for your MSP business?
M&A is front of mind for MSPs
In addition to the completed M&A deals that are reported almost daily, surveys indicate that even among MSPs who have not yet been directly affected – a fair number are thinking about M&A, with 69 per cent considering being acquired and 19 percent considering doing the acquiring, according to a recent IT Glue Survey.
This is confirmed by the 2018 Channel Futures MSP 501 report, with 53 percent of the 501 companies on the list stating that they are considering a merger or acquisition in the next 12-24 months.
What is driving this activity?
With MSP/MSP M&A activity, there are seven main drivers.
- The exit of the baby boomer MSPs
As reported in Channel e2e, thousands of baby boomer owners are looking to exit their businesses and unlock net worth from the companies they created. As part of this trend, M&A activity among MSPs is expected to rise at least through 2022 before levelling out – although, while receptive, not all MSPs will succeed in being acquired.
- Increasing customer expectations of a ‘one-stop shop’ for IT service needs
The expectation of managed information security (IS) services being delivered alongside IT services springs to mind immediately here as it is a challenge facing many MSPs currently. Indeed, managed security service providers (MSSPs) featured in the top sectors for M&A activity in Q3 2018, according to Momentum Cybersecurity’s latest tracking report.
If you are unable to provide the additional services customers expect, you risk losing that customer to a better resourced competitor.
- Access to new technology skills
You may be focussed on your own growth – but your customers are growing their businesses too, and may be deploying the latest technologies to enable that growth.
Have your skills and resources kept pace with the latest developments so you can manage this new technology? If the answer is no, acquisition could be a quick route to acquiring new specialisations.
- Access to additional resources
‘Bigger’ usually means being more competitive, by delivering broader service coverage and having more resources available to scale your MSP business.
- Geographical expansion/consolidation
Not a new phenomenon but an increasing trend for MSPs to merge or acquire other MSPs in an attempt to become the dominant brand in a ‘metro’ area and/or gain a foothold in a new geographic region.
- Vertical market entry/consolidation
While many MSPs support customers successfully across vertical sectors, there is a risk in opting to be a jack of all trades – you may be perceived as master of none and this can leave you exposed. Without an in-depth understanding of your customers’ business environment, it is more difficult to add unique value.
Some verticals have a hefty regulatory environment, with implications for technology and the way it is managed: healthcare, financial services and legal spring to mind.
As it can take considerable time and a significant amount of resource to build up experience and demonstrate compliance in one of these sectors, some MSPs shortcut the process by merging with or acquiring an MSP that already has that expertise and has already jumped through the necessary hoops.
- Bolstering ‘business’ skills
Apart from enabling you to bring in the skills you need to keep abreast of new technologies and customer expectations, weaknesses in areas such as process and methodology, compliance or even sales and marketing could be remedied by merging with or acquiring an MSP with complementary skills.
Outside of the MSP/MSP activity, there also appears to be strong interest from investors.
MSPs and MSSPs seen as good investment opportunities
With valuations high and capital relatively cheap, IT services companies are viewed positively by venture capitalists (VCs).
A recent Channel Futures article suggested that many of these VCs are snapping up multiple MSPs and OEMs, combining them into a single ‘powerhouse’. The reason for the appeal according to the article is that MSP consolidation is relatively simple. Most MSPs are ‘lean’ so growth prospects are good – particularly when combined with the strong relationships MSPs have with their customers.
Is this then the end of the Channel as we know it?
In the future, will success depend on being a ‘super-MSP’ or part of a ‘powerhouse’?
Not in some minds.
Charles Weaver, industry thought leader and CEO of MSPAlliance, continues to assert: “I remain steadfast in my opinion that there is no MSP consolidation taking place.”
In a recent article, he points to two fundamental reasons for this:
- Demand for managed services has never been greater
- More MSPs are entering the profession every day
He explains the M&A activity we are seeing as:
- Normal M&A activity, no different from previous years
- Representing owner/investor transitions
- Enabling expansion into new geographic markets
- Enabling expansion into new service markets
In an earlier article, Weaver pointed out that the predicted mass exodus of baby boomer MSPs is now much less of a stampede because the US tax and regulatory conditions that drove many smaller MSPs to seek an exit strategy have changed. Many of these same MSPs now see a lot of growth potential in the future, making M&A less crucial for them.
ConnectWise CEO Arnie Bellini and (now) former Datto CEO Austin McChord also queried the “20/80%” predictions, in a panel session at GlueCon, reported by Channel e2e.
Bellini compared the MSP sector to the accountancy sector, noting that there are big, national CPA firms, successful regional CPAs and thriving boutique CPA firms. Success depends on how well each runs their business. He believes the same will hold true in the IT services sector.
And in the same session, McChord largely dismissed MSP market consolidation “chatter”, pointing out that innovation was at the heart of revenue and business growth.
Does that mean market consolidation is being over-hyped?
Quite possibly according to Weaver, who commented:
“In lieu of a viable seller’s market, I believe these advocates for managed services consolidation must create a false sense of market consolidation.”
The other thing is that while there is strong interest from investors in MSP acquisitions, they are looking for businesses with a particular profile – and of a certain size.
Commentators point out that PE firms are looking for MSPs with a minimum of $15 million in annual recurring-revenue and double-digit margins, while according to Service Leadership CEO Paul Dippell: “PE firms want to buy MSPs and TSPs that each post $5-$10 million in profit.”
That narrows the opportunities considerably.
Does the future really belong to the ‘super-MSP’?
While MSP consolidation looks set to continue for the foreseeable future, it is not yet clear what the Channel will look like when it has run its course – or which MSPs will be left standing.
‘Big’ may be better and bring benefits: access to more resources, a wider range of skills and experience – and access to capital, for example.
But ‘small can be beautiful’ and when applied to MSPs, it can mean greater agility, a closer connection to customers and the ability to serve niche markets cost-effectively.
So, I think I’m with Arnie Bellini in seeing opportunities continuing for MSPs at all three levels: national, regional and niche. The key thing is to keep our customers happy.
We can’t afford to ignore the new services expected by our customers (MSP partners in my case) – and there’s no one-size-fits-all solution when it comes to acquiring the new skills we will need. We may choose to develop these in-house – or merge with/acquire another MSP to access them more quickly.
And of course, there is always the option to partner to access new or additional skills and resources.
Contact us or chat now to find out how we can help you manage your NOC and Service Desk while you focus on growing your MSP business.