How To Negotiate Managed Service Contracts With Existing Customers

If you are a frequent reader of this site you have probably heard us talk often about “shedding your skin” in order to achieve growth. When a snake hits certain phases in its life it begins to “molt.” This is the act of shedding its most outer layer of skin to shed parasites and release it’s juvenile scales, both of which restrict the snake from growing. The same can be found true for Managed Service companies in the form of outdated contracts from their most loyal customers. If these contracts are not shed and renegotiated to fit current operating costs and future goal, this could up creating a lose/lose partnership for both parties. If your company is one of the thousands of MSPs with unprofitable service contracts from long-standing customers, than these tips negotiating tips are for you.

Know Your Costs

Before any negotiating can begin, the first thing that needs to documented are your costs for servicing the customer in question. While gathering up your licensing and software costs might be rather simple, labor costs are typically the area where most companies struggle.

The first step in truing up your labor costs is to create a spreadsheet that lists every employee on your service team and calculate their hourly expense. This should include payroll taxes, benefits, insurance and any other costs associated with employing each individual. For companies with significant overhead expenses, you may want to include your total over-head expenses in this calculation, divided evenly among each employee.

After you know each employee’s hourly cost, you should then input their rate into your professional service automation platform as their “resource cost.” This will now allow you to pull a Profit & Loss by contract report from your system. A P&L by contract will detail all the labor that was performed under the contract, how much it cost the company, and how much was billed to the customer. This report is extremely powerful when accurate, especially when your team has good time-tracking habits.

Create A Usage Projection

If you know your average monthly costs for servicing a contract and can prove that it has become less profitable over time, then there is no reason to not disclose this to your customer. Rather than handing over a confusing and exhaustive financial report, a simple summary and explanation of the numbers will do. Showing that you are organized, keep good records, and can prove profitability is the important part and will go a long way in building your case for a new contract.

Included in your financial summary, you should include a projection for how much you estimate service desk usage and costs to be over the next 12 months of the contract. If the customer’s usage has trended up year after year, you should be able to identify this through reporting and plan accordingly.

Once you have a usage and cost projection, you can add your desired profit margin on top of it. This will give you a fair price to negotiate that will be very hard to dispute. It is important to remind yourself through the process that there are only two ways to feed growth. One is profit and the other is capital (including resources/time). For every dollar you don’t return in profit, that is a dollar out of your pocket in capital or precious time spent to compensate. The more you can improve your margin through negotiation, the faster you can accelerate your growth.

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Delegate Discussions (If Necessary)

Sometimes the act of renegotiating an old contract is more of a personal challenge than a professional one. When someone gives you their business early on and stays loyal to your company throughout the years, then it can be difficult to turn around and ask them for increased compensation. The thought of potentially “forcing out” these otherwise good customers is what keeps MSP Founders up at night and makes them hesitate to act.

If the uncomfort of these conversations is what is preventing you from having them then it is possible that delegating the responsibility is the best option. Giving someone that was removed from the origination of the contract full authority over the renegotiations will help move things along.

It is important not to micro-manage during this process. The customers will likely try to rope you in so that you can to save their “sweet deal.” If you choose to delegate, you have to stand your ground and ensure the customer that your employee or partner has your full trust and the authority to restructure the contract any way they feel is appropriate. Undermining them will only create more problems later on, as customers will begin to believe that they can just “climb up the totem pole” to get their way.

Offer An Incentive

When a customer is exceeding normal usage of your service, there is most likely a reason why. On occasion this reason is more behavioral in nature, but the majority of over-utilized contracts stem from technical issues that just need attention.

In this scenario, it might be possible to incentivize your customer to approve projects to ultimately resolve these issues, bring utilization down to a normal level. For example, if a large percentage of the customer’s service tickets are related to email, you can give them the option of two new contract options, one that includes the current usage projection (significant increase) and another that includes immediate approval of an email migration with a lower contract increase.

If the customer agrees to your incentive and you can show that usage declined as a result of their decision, it can help build trust in your relationship. You may even be able to get the customer on-board to complete other projects, offering them more financial savings to do so.

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Know When To Walk

The most important part of the renegotiation process is knowing when to just walk away. It’s entirely possible that you take all the steps we mentioned above and the conversation still comes to an impasse. In this situation, it is important to reflect on why exactly the customer will not agree.

If you were transparent in your reporting to the customer, accurate in your projections, fair in your request for margin, and flexible in offering an incentive, than there should be little reason for a customer to say no. In a true win/win partnership, your customer should want you to succeed. They should understand that you are operating a business, that needs to make a profit to survive and grow.

For situations where the customer simply can’t afford your proposed rate, you should consider what kind of customer they are. If they are a pain to deal with and are never satisfied, then walking away is probably best. If the customer is great to business with and even refers you new business, then it may be worth keeping them around, chalking up the loss as a lead generation expense.

In conclusion, for those of you that are struggling to generate profit, the answer it very likely in your least profitable service contracts. If you can identify these and fix these leaks, you are likely to see significant swing in the right direction. The conversations are difficult, but nothing is more difficult than trying to grow a business while giving away your profit to customers.