‘Seventy-five [percent] to 80 percent of the cost of goods sold for managed services is people. That’s why it’s so critical for every MSP to understand how they can grow efficiency through agentic AI and automation,’ says Peter Kujawa, executive vice president and general manager of IT Nation Evolve and Service Leadership at ConnectWise.
AI and automation are creating significant opportunities for MSPs to improve efficiency and profitability, but not every MSP is benefiting equally. In fact, the gap between the industry’s top performers and those struggling to make money is only getting wider.
Peter Kujawa, executive vice president and general manager of IT Nation Evolve and Service Leadership at ConnectWise, said the Tampa, Fla.-based vendor’s latest industry benchmarking data shows that while organic managed services revenue growth is returning to historical norms, a large portion of MSPs are still struggling to grow their business.
Organic managed services revenue growth averaged 11.8 percent over the most recent four quarters, approaching the industry’s historical norm of 12 percent, according to Kujawa. However, 61 percent of MSPs are growing below that rate, while 25 percent are experiencing zero or negative managed services growth.
Kujawa believes the difference isn’t about company size or access to technology, but rather operational maturity, business discipline and how effectively MSPs manage their people, processes and resources.
AI and agentic automation are also emerging as major differentiators. Because labor accounts for 75 percent to 80 percent of an MSP’s managed services cost of goods sold, improvements in technician efficiency can have an impact on margins, Kujawa said. Top-performing MSPs, he added, are already seeing greater efficiency gains, even as their tool spend increases.
He believes MSPs that effectively implement automation could increase their capacity by 40 percent to 45 percent over the next 18 to 24 months without proportionally increasing head count. That could allow MSPs to take on more customers, improve profitability and give employees more time to focus on higher-value work.
Evergreen M&A advisor and ConnectWise Evolve peer member Craig Fulton said MSPs in Evergreen’s portfolio that have been growing managed services by focusing on business outcomes have been the first to expand revenue by delivering AI technologies to customers.
“We’re also seeing what [Service Leadership] is reporting,” Fulton told CRN. “We began to see this in our businesses first starting in Australia. They were moving first on delivering AI-related projects to customers and mapping out a playbook for how to expand revenue with AI. This created a new role, and we’re investing in bringing more forward-deployed engineers to our MSPs to expand growth.”
But getting there requires more than buying new AI tools. Kujawa said MSPs must first understand their financial performance, establish profitability targets and build a business model that can support sustainable growth.
CRN spoke further with Kujawa about the financial challenges facing MSPs, the growing profitability divide, how AI is changing service delivery and where MSPs should invest now to prepare for 2027.
What are some of the biggest financial challenges MSPs are facing right now?
Most MSPs are struggling to grow revenue. Our data says organic managed services revenue growth over the most recent four quarters is 11.8 percent. The historical norm is around 12 percent in the industry, give or take. So we’re right at a historical norm. Growth came way down, but over the last eight quarters it’s been steadily going back to normal.
The problem is that 61 percent of MSPs are growing slower than that, and about 25 percent are growing their managed services revenue at zero or less.
Remember, that number is net revenue, so it’s new revenue minus churn. Churn is somewhere around 5 [percent] to 10 percent, depending on whether you’re looking at best-in-class or bottom-quartile MSPs. If you’re churning even 5 percent, you’ve got to outsell that. But 10 percent is a lot. You might be adding new customers, but if you’re churning 10 percent a year or more it gets pretty hard to outrun that.
The other issue is the huge difference in profitability between best-in-class, median and bottom-quartile companies. Our data showed that best-in-class MSPs averaged 23.9 percent profitability in Q3. The bottom quartile was negative 0.6 percent.
So 25 percent of partners are making, on average, effectively zero, while another 25 percent are doing really well, with profitability in the mid-20-percent range. Partners in that bottom quartile, and even those in the median, need to improve their business practices and their business results.
What are you seeing when it comes to MSP profit margins?
Again, it’s a tale of best-in-class, median and bottom-quartile providers. Best-in-class MSPs are starting to pick up some tremendous efficiency gains from AI and automation. They’re actually spending more on tools at a rapid clip, but they’re getting so much scale in their businesses and improving efficiency so quickly that they’re improving their gross margins at a really rapid clip.
Bottom-quartile MSPs aren’t improving at all. Everybody has access to the same tools and the same knowledge base about how to run a business. I’m pretty religious about this: You need to fix your business model. It’s not a growth issue. A lot of MSPs believe they can grow their way to profitability, and it doesn’t work that way. You need to fix your business model first, be profitable, and then grow.
So what are the biggest steps MSPs can take to fix their business models and improve profitability?
Seventy-five [percent] to 80 percent of the cost of goods sold for managed services is people. That’s why it’s so critical for every MSP to understand how they can grow efficiency through agentic AI and automation.
The ConnectWise product announcements over the last week have been really amazing. The RMM agent is one example, and partners can start getting benefits from it within a day or two. It’s not just the RMM agent, but also the ticketing agent for calls and Teams messages.
I think that over the next 18 to 24 months, an MSP should be able to pick up 40 [percent] to 45 percent capacity compared with where they are today if they’re doing this right. In other words, if I have $1 million in managed services revenue today, I should be able to grow to $1.4 million over the next couple of years without having to add a person.
If you can do that, you’re getting tremendous improvement in your margins, and the business model just changes. You’re opening up the ability for employees to do higher-level work. The other thing is that hiring has been one of the biggest challenges for MSPs for many years, in addition to sales and marketing growth. Our data says MSPs turn over help desk technicians at about 22 percent per year.
Agentic AI isn’t about implementing this and getting efficiency gains so you can fire people. It’s about growing your capacity and not having to backfill as quickly as you would have before. If you can grow your business with proportionally fewer people as you scale, it makes life easier.
What separates those best-in-class MSPs from the providers that are struggling?
They’re running their MSPs at a higher operational maturity level. Service Leadership trademarked the term ‘operational maturity level’ about 15 years ago. It refers to how well-run a business is.
We measure 46 different traits that cover all aspects of running an MSP. Our SLIQ assessment tool asks about 185 questions and tells providers their operational maturity level, what they need to improve, what they’re doing well and what they should keep doing. It also prioritizes where they’re going to get the greatest bang for their buck.
Our data says that, on a scale of one to five, top-quartile MSPs have an operational maturity level of 3.8 or higher. Bottom-quartile MSPs are at 2.9 or lower. That’s not a huge spread numerically, but it’s a lot of work. You need to run your business in a different way.
The single most important operational maturity trait is value creation strategy. Does the MSP know what it’s trying to build its business into over the next five years?
Specifically, how big do you want it to be? How profitable do you want it to be? What do you want its valuation to be five years from now? That doesn’t mean you have to sell in five years, but knowing what you’re trying to achieve dictates a lot of the decisions you need to make.
If my value creation strategy requires me to grow 10 [percent] to 15 percent year over year for the next five years, that’s probably viable. That’s about normal industry growth. On the other hand, if I need to grow 30 percent a year, I’m probably going to have to do some M&A or something different because that’s much faster than normal MSP growth. Understanding where you are today and what you’re trying to build drives all sorts of other business decisions.
How is AI directly impacting margins, and where should MSPs invest first to see the greatest financial return?
For the best-in-class providers, it’s showing up significantly because they’re improving their labor efficiency. Even though they’re spending more on tools, that’s OK because tool costs are only about 20 percent of an MSP’s cost of goods sold. People account for about 80 percent.
If I’m buying AI capabilities and increasing the capacity of my business, adding more customers without hiring technicians at the same rate, I’m automatically improving my gross margin. Those efficiency gains are translating into better gross margins and better profitability. We’re seeing it directly in the data. The median is improving a bit, just not as fast as best-in-class. The bottom quartile is totally flat. They’re not improving at all.
If I’m running an MSP today, my advice is to join a peer group and get your data so you know where you need to take your business. Otherwise, you’re operating in the dark. You’re getting advice from people who may or may not be giving you good advice.
As MSPs plan for 2027, how should they rethink workforce planning as AI takes on more work?
MSPs should be thinking in terms of some of the ratios we teach using Service Leadership data. We teach service gross margin and how to compute it, but they should also be going through a budgeting process to plan for the year.
They should be setting targets for gross margin and profitability, and then going back and looking at labor almost like they have a salary cap. If they’re going to add a certain amount of revenue and have a certain gross margin, while trying to reach a specific profitability target, they know what their general and administrative costs are. They know their rent and executive expenses. They should have a good idea of what they’re going to spend on sales and marketing.
What’s left is what you have to work with to staff your team. Most MSPs start the other way. They look at the revenue coming in, then decide to add a technician for every certain number of users they bring on. Then they look at sales and marketing, and whatever is left becomes their profitability.
Set your profitability as a goal and work backward.
The other thing is that one of the most important KPIs outside of EBITDA for an MSP is its service multiple of wages. That’s how many dollars of service revenue you’re billing for every dollar you spend on your service team.
Historically, we taught 2.5 as the number to target. Today, the service multiple of wages for best-in-class MSPs is hitting all-time records and improving at an unbelievable pace.
The all-time record we saw two quarters ago was 3.01. Last quarter, we saw it jump to about 3.3 or 3.32. These records are being broken every quarter. They’re not just being broken; they’re being smashed. The bottom quartile is flat. They’re not improving it at all. The median is improving, but not as fast.
So what’s ahead for Service Leadership in 2027? What can MSP partners expect?
We’re going to continue improving our benchmarking platform. We just added a brand-new KPI called the Automation Index. It takes six of our KPIs that we think each have a different measurement value for efficiency gains within an MSP. It weighs them and gives an overall score showing how the provider compares with best-in-class, median and bottom-quartile performance. That’s live, and we’re excited about the data it’s going to provide.
We also recently launched parent-child benchmarking. That allows an MSP doing acquisitions to benchmark each acquired entity individually and then roll everything up. They can have a parent-company view while seeing how each individual entity compares across our KPIs.
We’re going to continue enhancing those capabilities. We’re already working on getting the Service Leadership Index built into the platform next year, so a partner using PSA and RMM will be able to access its Service Leadership data within the platform.
We’re also moving SLIQ into the platform, so partners won’t have separate logins. It’ll be a single tool they can use, and it’s just going to add more capabilities for them.
