Calculating Revenue Per Employee
It’s undebatable that as a service-based business, the true value of an MSP is in its people. While this can seem difficult to quantify, some financial analysts attempt to do so using a metric known as Revenue Per Employee (RPE). This is calculated by dividing the total amount of service revenue by the number of full-time service employees responsible for producing the work. For example, if an MSP does $1,000,000 in revenue annually and has a team of 10 employees, then their RPE is effectively $100,000.
It’s important to note that this is a widely used formula, and while some industries will use all employees in their equation, MSPs have the benefit of a more clearly defined line between those responsible for producing the end product / service and those who are not. Omitting the team members in departments such as Sales & Marketing, can lead to a more accurate figure and one that becomes more actionable as well.
MSP & IT Industry Benchmarks
One of the great features of RPE is that it can be very useful when compared to an industry benchmark. This is why it is commonly used by private equity firms and investors to estimate whether a company can support additional growth. Afterall, they want the value of the company to increase after their investment and ideally this can be accomplished without adding additional expenses. I was curious as to what benchmark is commonly used to analyze an MSP business, so I reached out to Hannah Paige and our friends at Worklyn Partners.
As she explains, “[We] consider $200k the magic number when it comes to service revenue per service delivery employee, and we use this benchmark for all MSPs we look at (even our own!). After seeing hundreds, if not thousands, of deals in the space, as well as having operated 4 IT services businesses, we recognize that when this metric is above $200k, the MSP is understaffed and needs more service employees. Conversely the opposite is true when this metric is below $200k, it means the MSP has too many services employees and the MSP has capacity to onboard new customers without making additional hires.”
The Outsourcing Factor
There is one flaw in this formula that can really throw off the results for MSPs, and that is outsourcing. When you outsource Engineers and Technicians via a service, staffing firm, or as a freelancer, you have the ability to scale revenue without necessarily increasing your full-time head count. At the same time, your revenue per employee is likely to be well above the benchmark, which may seem like a good thing, although it becomes a far less useful means of comparison.
Another issue with this, is that you may remember me saying earlier that “the true value of an MSP is in its people.” In an outsourcing situation, the actual value of the service is not retained by the company. While this is a non-factor if it is a “lifestyle business” that is primarily meant to support the Owner, but otherwise it becomes far less investible. This is because when the value is essentially rented, there is far more risk in the MSP’s ability to service its customers.
What You Can Learn
Assuming that we are analyzing an MSP with a traditional service organizations and limited outsourcing, lets dig into a few hypothetical scenarios and see what we could learn about them:
Operational Efficiency
A high revenue per employee is a strong indicator of operational efficiency within your MSP business. It suggests that your team members are highly productive and that your business processes are very well streamlined. This means that your employees can handle significant workloads and deliver high-quality services without being overwhelmed or getting burnt out.
This level of efficiency is usually a result of well-designed processes, effective use of tools / technology, and a clear understanding of employee roles and responsibilities. Given that these are all signs of maturity for an MSP, this can also be an indicator that your company is well-positioned for growth. The best part is that a lot of that growth will likely happen organically. This is because all the operational efficiencies tend to improve customer satisfaction and thus generate more referrals.
Pricing Strategy
Revenue per employee can provide valuable insights into your pricing strategy. If this metric is lower than industry benchmarks but your team is at capacity, it may indicate that your services are underpriced. This underpricing can stem from poor scoping, a lack of market research, failure to increase rates over time, or simply over-competitive sales tactics. By analyzing revenue per employee, you can determine if your current pricing strategy adequately reflects the value you provide to clients and adjust accordingly.
I recently asked Daniel Welling of The MSP Finance Team how he recommends handling these scenarios. As he describes, “Ideally [labor utilization] and profitability data would be accurate and timely from the PSA, however a shortcut to get started here is “effective [labor] rate”, which does require basic time tracking as a data source; divide the number of hours logged against a billing agreement revenue (net of product & tool costs, sense checking time logged for reasonableness) if that surfaces an hourly rate well below target [..], you then have the confidence to demonstrate to the customer unsustainability and explore collaboratively how to improve (which could be a price increase or a reduction in scope for the MSP.)”
Employee Utilization
Employee utilization is another critical aspect that revenue per employee can highlight. Low revenue per employee may indicate that your team members are not being fully utilized. This underutilization could result from an inefficient delegation of work, poor project management, or simply from employees spending too much time on non-revenue-generating activities. Ensuring that your employees are always engaged in meaningful, billable work is crucial for maximizing their productivity and your overall revenue.
As James Vickery, CEO of Benchmark 365 explains, “When accounting for sick leave, annual leave, and work latency, a tightly managed helpdesk’s average technician utilization is only about 60%, with 20% wastage equating to 384 lost hours annually. Utilizing an outsourced helpdesk with a ‘pay per incident’ model ensures 100% utilization, eliminating latency costs and maximizing financial efficiency, while high-performing resources can focus on consistently billable projects.” He is correct in the sense that if your revenue per employee and utilization are both low, but you aren’t in the position to decrease headcount, outsourcing becomes a far more attractive option.
Model Scalability
Revenue per employee can reveal a lot about the scalability of your business. If the metric remains consistently strong as you grow and add more employees, it indicates that your business model can support growth without a proportional increase in costs. This scalability suggests that your foundational service offering, infrastructure, processes, and workflows are ultimately robust enough to support your expansion efforts.
However, if revenue per employee declines as your team grows, it may also be a sign of scalability issues. These issues could be tied to inefficiencies in onboarding new employees, lack of training, or an absence of clear processes that can be replicated at scale. Addressing these challenges is critical for sustainable growth.
Resource Development
A dip in revenue per employee can indicate a need for better training and resource development. Employees who lack the necessary skills may struggle to perform their tasks efficiently, leading to lower productivity. Investing in comprehensive professional development programs makes sure that your team stays up-to-date with the latest industry trends, technologies, and best practices. Continuous learning opportunities, such as workshops, certifications, and online courses, also help employees enhance their skills over time. This investment in training not only improves individual performance but also boosts overall team efficiency, contributing to higher revenue per employee.
Another benefit of resource development is that specialized technical skills are in high demand and often yield much higher hourly rates. When you are able to grow this talent internally, you will often pay less than it costs to hire on a freelance or permanent basis. These skills will unlock new opportunities and may increase revenue per employee without a proportional increase in employee cost.
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