Gross Margin: The ONE Metric Every MSP Needs to Know

Today, I want to dive into a topic that’s crucial for any Managed Service Provider (MSP): gross margin. If you let me talk long enough about MSP finance I’ll likely say something to the effect of, “Gross Margin is the best financial metric to predict how profitable your MSP is.”

Properly managing your Gross Margin is key to the financial health of your business.

My name is Adam Hannemann, welcome to Ramblings of a Geek. I’ve been in the MSP space for a coupe decades, and I’ve spent a lot of time working on MSP finance over the past decade.

Let’s dive in on all things Gross Margin.

Understanding Gross Margin

First, let’s start with the basics. Gross margin is simply your revenue minus your cost of goods sold (COGS). But it’s not just a number—it’s a key indicator of your business’s health. For MSPs, it’s essential to track gross margin across different lines of business:

• Nonrecurring products: Think hardware, perpetually licensed software, and other one-time purchases.
• Recurring products: This includes things like security stacks, Microsoft 365 licenses, and other subscription-based offerings.
• Recurring services: Your monthly managed services, break-fix work, and project-based services.

The key here is to track these categories in a way that informs your business decisions. If the data isn’t driving action, it’s not worth the effort.

The dollars aren’t the full picture, so we prefer to think about Gross Margin as both a dollar value AND a percentage of revenue. As you add new clients your Gross Margin dollars will go up, but without knowing Gross Margin as a percentage of revenue you might be adding more margin but working harder to generate that incremental margin.

Measuring Gross Margin as a percentage of revenue allows you to compare yourself against yourself, yourself against industry data, and if you are in a Peer Group (and you should be) yourself against Peer Group members.

The Math

Here are the simple formulas for understanding Gross Margin as dollars and as a percentage of revenue:

• Gross Margin $ = Revenue – Cost of Goods Sold (COGS)
• Gross Margin % = Gross Margin $ / Revenue

Why Gross Margin Matters

Gross margin isn’t just a financial metric—it’s a reflection of how efficiently you’re running your business. For MSPs, the biggest levers to pull are often in the services side of things. Here’s why:

• Service COGS primarily consists of technician salaries (fully burdened) and tools like your PSA, documentation software, and remote access tools. Your labor COGS are typically 90%+ of your total Service COGS, so paying attention to those COGS is key.
• Service gross margin is calculated as service revenue minus your total service COGS. But the real insight comes when you look at service gross margin percentage—your margin dollars relative to your revenue. [math: Service Gross Margin % = (Service Revenue – Service COGS) / Service Revenue]

This percentage allows you to compare your performance against industry benchmarks. For example, if the industry target is 65% and you’re at 57%, it’s important to understand why. Are you deliberately overstaffing to give your team a break? Or is there inefficiency that needs addressing?

Strategies to Improve Gross Margin

If your gross margin isn’t where you want it to be, you have two main options: increase revenue or reduce COGS. Let’s explore both (in fact, if you can do both you’ll really move your Gross Margin).

Increase Revenue

• Raise prices: If you haven’t adjusted your rates in a while, now’s the time. For example, $150/hour should be the floor for hourly rates in the U.S. I’ve talked about raising rates a couple of different times. Check out this video to learn how to handle MSP Price Increases.
• Tiered pricing: Charge higher rates for advanced services like project work or consulting. Level 3 technicians or consultants should bill at a higher rate ($200/hour or more). This is especially important if you’re paying your highly skilled staff in the low six figures. If your normal hourly rate is $150 an hour then charging $200 or $225 an hour for high level engineering or projects is totally valid.

Reduce COGS

• Manage salaries: Pay your team fairly, but avoid overpaying. Plan for raises, promotions, and new hires in advance to avoid unexpected COGS spikes.
• Streamline tools: Audit your toolset regularly. Are you paying for tools you don’t use? Eliminate waste to reduce unnecessary expenses.

The reality with COGS is that your labor will account for 90%+ (probably 95%+) of your total Service COGS. Said differently, definitely manage your tools, but if you really want to move your margin, managing your labor COGS is where the big moves happen.

Manage Team Efficiency

Ensure your team is logging time accurately and billing appropriately. A good target for most service related businesses is 75% billable/utilized for the year. If you’re aiming at 75% for the year you actually need to increase the daily billable to 80-85% to account for things like PTO.

The problem is, if you tell your team to be 80-85% billable it’s in a unit that they don’t really care about. When giving your team metrics (KPIs) to work towards you MUST give them the metric in a unit they know AND can control.

So, aim for 6.5 billable hours per day per technician. If you routinely hit 6.5-7 hours of utilized time you’ll be fine.

Another item to consider around MSP Team Efficiency is the impact of meetings on your utilization. Adding meeting after meeting has an outsized impact on overall utilization, so make sure that the meetings on your teams’ radar are worthwhile. Meetings can be great, but they can also be terrible. Make sure these meetings land in the great category.

The Role of Fixed Fee Agreements

Fixed fee agreements are a goldmine for MSPs—if managed correctly. Here’s how to maximize their efficiency:

• Shadow billable: Compare the time you bill clients under fixed fee agreements to the time you would have billed under a time-and-materials model. Aim for a ratio greater than 1.
  • The math here is simple: Shadow Billable = Actual Service Charge /  What you would have charged with T&M.
• Client segmentation: Focus on your most efficient clients (those with high shadow billable ratios) and address inefficiencies in your bottom 20% of clients.
  • Highly profitable clients should “feel the love” and make sure that they know you are paying attention to them. The last thing you want to have happen is for a highly profitable MSP client firing you because they didn’t feel you did enough for them. Send a tech out and do a walk around, bring some bagels, or generally just be a little bit more present to show that you care.
  • Less profitable clients are in need of some TLC to get them to move up. Do they need some projects completed to solve some issues? Are they not up to your standards? Do they have some difficult users? This is an opportunity for you to dig in and move them up. When you do this across several less profitable clients you will solve their problems systematically which frees your team up to do other things. Everyone wins!
• Standardization: Ensure new clients are onboarded efficiently and aligned with your standards. This reduces the time it takes for them to become profitable. I’ve recorded videos and have a comprehensive blog post (with the videos). If you want to upgrade your Onboarding process check out this article.

There are tools that can help with this. My favorite tool and unequivocal recommendation is MSPCFO (https://mspcfo.com). They are excellent at this, and in my former MSP life we used their tool to move our bottom tiered clients up by something like 50% over the course of a couple years. It took some time and effort, but having the data on hand, all the time, made it much easier to track progress.

The Bigger Picture: EBITDA and Valuation

Managing gross margin isn’t just about short-term profitability—it’s about building a sustainable, valuable business. By consistently improving your gross margin and EBITDA, you’re setting your MSP up for long-term success. Whether your goal is to run a well-managed company or prepare for a future sale, these strategies will put you on the right path.

All that said, if you aren’t heading towards an imminent sale and want to overstaff your company on purpose I won’t talk you out of it. Taking a deliberate hit to Gross Margin and EBITDA by overstaffing isn’t the worst thing in the world. On the other side, if you don’t know why your Margin and EBITDA aren’t great then that’s an issue to solve!

Final Thoughts

Gross margin is more than just a number—it’s a reflection of how well you’re running your MSP. By focusing on revenue growth, cost management, and operational efficiency, you can create a healthier, more profitable business. And if you’re an owner, consider involving your Service Manager in this process. When everyone understands the importance of gross margin, you’re more likely to make better decisions together.