Why Monthly Recurring Revenue Must be the Life Blood of Your MSP
MRR stands for “Monthly Recurring Revenue,” AKA the gift that keeps on giving is money that you earn from your customers every month.
MRR is crucial to an MSP because it perfectly fits the business model: you provide service and support over many years and get paid every month. Once you’ve made the sale and delivered fantastic service, you won’t have to make that sale again.
MSPs underestimate the value of MRR.
I recently spoke with an MSP who set a goal of an additional 500k of sales for the year. The owner thought it was a huge goal requiring him to sell just over $41,666 a month (500k/12).
If he sold $41,666k of MRR in one month, he’d meet his goal because he didn’t earn money just once. He earned it every single month.
At an average customer value of $5,000, he thought he’d need 8 new clients a month, but in reality, he needed 9 in total.
Now, he did want 500k for the whole year, so he’d need all these new customers in one month to meet his target. But if he added just one additional average customer each month, he’d have $390,000 in additional sales for the year and $720,000 in additional sales in the next year. Sure, he’d miss his target for the year, but he’d be very happy next year.
So instead of fretting about adding 8 customers every month or doing one-off (low-margin) project work, we created a plan to add 1 new customer every month.
Just one.
MRR isn’t just good for revenue; it’s more profitable too
As an MSP, MRR should be your most profitable revenue. Here’s why:
Every project is different if you are doing one-off break/fix work. You never know what you’re going to find. You’ll charge by the hour because there is no way for you to predict a project’s time and effort effectively. Your earning is limited by the number of hours you work.
There is another problem: with project work, you estimate the total, do the work and send the client the bill. You likely underestimated the hours spent, so you charge more than expected. Now your customer is unhappy, and you must have an uncomfortable conversation.
You’ll probably give them a discount.
So not only are you limited by the number of hours you have available, you won’t even be able to charge the total amount.
MRR works differently because it is a subscription to your Signature Program. You deliver the same program repeatedly, so you get better at it. You create shortcuts, tools, tricks, and processes that allow you to do three things:
- You can do more with less because you make fewer mistakes and have to figure less stuff out.
- You can hire less skilled people to deliver your product.
- You focus your highly skilled people on developing new products to make you more competitive.
This gives you leverage.
You won’t completely divorce time spent and profitability, but you will significantly improve your situation over time.
Oh, and MRR helps you compete more effectively too.
As an added bonus, this dynamic always keeps you one step ahead of the competition. You are developing IP that others will struggle to replicate without your specific experience.
Your way of doing things, the solutions you employ, and the problems you’ve already solved are your IP. It is nearly impossible to develop IP without a Signature Program, but when you have one, and you sell and deliver it, you become smarter.
And then there’s cost: you bring down your cost.
As your cost declines, you will have more price flexibility when you find yourself in a competitive situation. You don’t have to lower your price, but you have the option to lower your price.
So MRR is crucial to your financial situation
Here are a few ways in which MRR can affect a company’s financials:
Revenue: MRR is revenue. So earning more MRR means making more revenue.
Predictability: MRR is a recurring revenue stream, so it provides a more predictable source of revenue for a business than one-time sales or transactions. This predictability can help a business plan for the future and make more informed financial decisions.
Cash flow: The predictability of MRR and the standardization of your product will help you predict your cash flow and reduce your expenses. This improves your cash flow situation.
Profitability: Standardization and the development of IP will help you drive down costs as you get better at what you do.
Valuation: if you want to raise funds or sell your company, MRR is a crucial metric to determine the valuation of the business. Investors and buyers often look at the MRR growth rate and predictability when making investment decisions.
How do I calculate MRR
There are several ways to calculate MRR. It’s a lot like skinning a cat…
However, as a rule of thumb, even though we call MRR monthly revenue we actually always mean monthly revenue minus the monthly direct cost of delivering that revenue.
If you have a service that you sell for $10 a month that costs you $9 to deliver, then your revenue is $10, but your revenue minus direct cost is $10-$9=$1.
This is important because you want to make decisions based on an accurate picture of your business, not an inflated one.
Now, let’s go through how to calculate MRR.
MRR for your product
To earn MRR, you must have pre-defined products that you sell. In this sense, products are bundled services you deliver to your customer. Here is an example of defined products, the green checkmarks are included services, and the red Xs are excluded services. Using this table, we create three different products: Basic, Plus, and Advanced:
Once you know what your products are, you add up the monthly costs for each service. Some costs will be per customer; some will be per endpoint.
Per-customer costs are those you incur for each customer that do not depend on the number of end users, backup, for example.
Per-endpoint costs are those costs that you incur for each endpoint.
Include both, and then calculate the value based on the number of endpoints.
Once you have the cost, you can work on your monthly pricing.
In this table, we’ve calculated the total cost and revenue per month per customer based on 1, 5, and 100 endpoints.
If we zoom in on the price and cost table:
You can see the monthly breakdown of cost, price, and your MRR after subtracting the direct costs of delivering the service. This is the number you want to focus on. Revenue is nice, but you want to make sure it’s profitable.
In the example above, you can see that 1 seat is always not profitable; selling one seat results in a negative MRR.
A hundred-seat customer, on the other hand, brings in between $2,200 and $4,400 every month.
This chart also shows an issue with our pricing; the two most profitable products are basic and premium, with the plus product well behind both.
With different-level subscriptions like these, you generally expect people to gravitate to the middle level of service. So your middle and premium services should be at least as profitable, often more profitable than the basic service. So if you see results like these, you will want to go back and adjust your product definitions.
Your expected MRR, therefore, is:
MRR = Total Revenue – (total basic endpoint cost x total basic endpoints) – (total plus endpoint cost x total plus endpoints) – (total customer cost x total customers)
MRR in your books
Your books tell you what your MRR was rather than what it will be.
The simplest way to calculate your MRR in your books is to separate recurring revenue from non-recurring revenue. Non-recurring revenue comes from things like:
- Projects.
- Break-fix work.
- Hardware sales.
- Setup fees.
It is revenue that you do not expect to continue on each month.
If you subtract this revenue from your total revenue, you end up with your MRR.
A more precise way to calculate your MRR is by product. In this case, you attribute revenue and cost to one of the three buckets (Basic, Plus, Advanced).
This can get tricky, but it can be done (your bookkeeper can help, or we’ll do another post on it), and the nice thing about this level of precision is that you can tell which products were profitable and which were not.
What is MRR Churn
MRR churn is a metric that measures the amount of monthly recurring revenue lost due to customer cancellations or downgrades during a given period. It is calculated by taking the MRR lost from churned or downgraded customers and dividing it by the total MRR at the beginning of the period.
MRR churn is an essential metric for MSPs as it indicates the rate customers are leaving or downgrading their subscriptions. High MRR churn can suggest that a company is experiencing difficulty retaining customers or that customers are unhappy with the service.
To calculate MRR churn, follow these steps:
Determine the MRR of all customers at the beginning of the period (for example, at the beginning of the month).
Determine the MRR lost due to customer cancellations or downgrades during the period.
Divide the MRR lost by the total MRR at the beginning of the period.
Multiply the result by 100 to get the percentage MRR churn rate.
Here is the formula to calculate MRR churn:
MRR Churn = (MRR lost due to churn or downgrades) / (Total MRR at the beginning of the period) x 100
For example, if a company has a total MRR of $100,000 at the beginning of the month and loses $5,000 of MRR due to customer cancellations or downgrades during the month, the MRR churn rate would be:
MRR Churn = ($5,000 / $100,000) x 100 = 5% MRR churn rate.
