Hamilton Helmer introduces the concept of “7 Powers” in his book titled “7 Powers: The Foundations of Business Strategy”. In that book he identifies seven areas of business strategy that when executed well, create the potential for persistent differential returns (i.e., the company consistently outperforms it’s competitors and creates lasting financial value).
In this post I will review this model against one specific type of business: the IT Managed Service Provider to demonstrate both historical trends in strategy and also where some future opportunities can be found and fought over.
Scale Economies
Leveraging economies of scale to reduce costs as production or operations scale up has been business strategy 101 for many years and there are countless examples across industries of how this can be executed. Examples include large manufacturing facilities, distribution networks, or technology platforms.
One option organisations can choose is to scale horizontally (also known as horizontal integration) merging with other businesses at the same level in the value chain. This method is typically done to add new complimentary capabilities, reduce competition or add scale of execution (i.e. more people).
Another option is to scale vertically (also known as vertical integration) where organisations merge with or expand into areas higher or lower in the value chain than they are today. This has the benefit of giving more control over the customer outcome such as improving quality and increasing profitability. Expanding further down the stack, can come with it’s own set of risks however, particularly if expanding into heavily commoditised areas.
IT outsourcing has two major categories: Managed Service Providers (MSPs) and Global Service Integrators (GSI). The business model of the GSI is foundationally built upon the notion of economies of scale, executing both in vertical and horizontal motions. These global businesses grow to the scale of hundreds of thousands of people and face all the challenges that come with that both for themselves and for their customers. Alternatively, the MSP typically focuses on horizontal integration to add further capabilities to an ever expanding portfolio to meet customer needs. The challenge for the MSP is in maintaining an appropriate scale for their customer base and not growing too quickly in order to avoid heavy competition from the much larger GSI.
For Managed Service providers, channel partners provide a quick way to add capability and test the market without committing fully to an acquisition. It also allows the organisation to better understand the capability they want to acquire and makes it easier to find those acquisition targets (also see: Network Effects)
This has been how MSPs have operated for many years. The real scale comes not just from scaling the number of customers, getting deeper into industries or expanding the number of employees but by how effectively the organisation can execute on the integration of those capabilities to provide additional value that is greater than the sum of it’s parts (also see: Process Power).
Switching Costs
The idea of switching costs is to create barriers for customers to switch to competitors, these can be financial, process or relational. Examples include software platforms where users invest time and effort to learn the system or subscription-based services where cancelling involves inconvenience.
MSPs have historically focused on this almost more than anything else. Contracts of 3, 5 or even 10 years were not uncommon. Agreements with early exit penalties and/or admin fees can see still be found. With Process Power being one of the other 7 powers, ironically having a worse process to leave can increase the financial and emotional switching costs associated with any service.
The reason I say some of these practices are historical, is not because they are completely eradicated (far from it), but because there are less customer-hostile methods of implementing a switching costs strategy available.
One of those methods is actually something that the MSP organisation want’s to achieve anyway - deeper integration. By having a portfolio of services that are tightly integrated and focusing on the customer adopting more of that portfolio, as well as increasing revenue you also increase value the customer gets from the service. The more value they get and the more services they consume the more emotional investment they have in that value.
A second related method is by combining offerings into a single platform. The platform approach focuses on building new products on top of your existing products effectively building an economic moat based on value, so that the customer will find it difficult to exit because they would have to replace all products in one go, not just single point solutions.
Counter Positioning
Counter Positioning is taking an alternative approach that disrupts existing norms or industry practices. Examples include low-cost airlines challenging traditional carriers or disruptive technologies replacing established products.
Taking a genuinely alternative approach is rare in the outsourcing industry, primarily because it’s not the reason why organisations outsource - they outsource for cost and the efficacy of execution of something well known, not because of innovation. However, that’s not to say there are not opportunities for counter positioning, typically when the focus has been on specialisation. MSPs focus on very niche technologies (such as mainframes) or on specific verticals (such as government or logistics) which allows them to position themselves against each other and set themselves apart. This has increased over years, particularly with smaller MSPs trying to set themselves apart from bigger, more generic organisations. Specialisation like this is an act of counter positioning but it’s likely to work counter to scale economies if not executed within a broader strategy. In the economic climate at the time of writing I suspect that we’re less likely to see specialisation and smaller companies are likely to be replaced or acquired by larger more generic organisations as consolidation occurs.
The key differentiator in the MSP industry has always been customer experience, the more personal and the more bespoke the customer experience feels, the more likely this counter positioning will result in better retention and increased customer spend. Where many industry players fall short is when the customer experience fails to scale as they grow or fails to adapt with changing industry or customer expectations. Is your service pro-active? Does it integrate with the customers own tools? Is it omni-channel? No, then there is the counter positioning for your service.
Network Effects
You’ve probably found this blog post as a result of network effects. It’s where the value of a product or service increases as more people use it. Examples include social media platforms, marketplaces, and communication tools.
As mentioned in Scale Economies above, the Network Effects for the outsourcing industry comes from partnerships with organisations. By partnering and collaborating with complimentary organisations it’s possible to increase scale by the incoming business coming from this diverse range of different sources. Having channel partners has been a concept in the outsourcing industry since inception - the only advantage here is the ability to manage and grow it.
For a more modern take on network effects we have to look at the Chinese company Haier and their concept of micro-enterprises. Intentionally small and autonomous parts of the business that collaborate together to meet a customer need. Like business units - but a more extreme scale. Why is this interesting? Well, it’s because they’ve artificially created Network Effects. Each micro-enterprise is allowed to make its own decisions and have it’s own specialisations and it’s own customers - but they are also incentivised to work with the other micro-enterprises with Haier. So it’s network effects - but without that bothersome problem of actually having to work with other companies - smart!
There is another way I have seen this appear. When a company acquires an entity (for it’s speciality) it keeps that organisation separated with an independent but common brand (see: Reply for a good example of this). The entity remains autonomous but working with it’s sister companies for scale and expanded market penetration.
One of the ways to remember Network Effects is the “the value increases the more people use it”. For managed service providers this comes into effect by building communities. Communities in this context is working a depth though the supply chain (i.e. your customer is my customer). By managing both sides of a relationship your able unlock unique insights for all parties that they might not otherwise see. Community building is quite different to the the 1-to-1 nature of the traditional channel experience and is an area where a lot of innovation can occur.
Branding
The least quantifiable but by no means less important of the 7 powers. Building a strong brand is about building that identity about who you are that influences customer preferences and loyalty. Examples include iconic brands like Apple, Coca-Cola, or Nike. The best brands provide an identity that you want to align with or be representative of your own identity. This is as true for B2B brands and their corporate customers as it for customer brands and their individual customers.
There two common themes of branding - “safe and stable” (giving customers what they expect) or “fun and innovative” (givings customer what they don’t expect) with many larger players trying to be both to different markets and diluting the brand in both scenarios.
The slightly darker side of branding is that a good brand and shiny modern marketing can often be enough to cover the patchwork of complexity and corporate issues that hide inside any large organisations. When MSPs and GSIs are made up of a patchwork of acquired companies across different countries - strong, well understood mission and consistent brand marketing can make it all seem a lot better than it is and can make you stand out vs the competition.
Branding is also very much “pay to play” where Garnet Magic Quadrants matter and which events you go to matter.
Brand is a long-term investment but the upsides are often the ability to price services higher as the value of your brand means more than the competition.
Cornered Resource
Now let’s talk about those niches! Controlling a critical resource or asset that others cannot easily replicate is known as Cornered Resource. Examples include access to unique data, patents, or scarce raw materials.
Typically in technology organisations this means acquisition of companies that are the leader in a particular market segment or have a speciality technology expertise (often also seen as an acqui-hire of talent). For MSPs and GSIs it’s common to see this happen more at the commodity end of the scale - grabbing resources (people and companies) that specialise in technology towards the end of it’s life. Think about all that AS400, Solaris or IBM DB2 business and you get the gist. Corning resource at this end of the scale means it’s possible to have higher prices because the supply of that resource in the market is very low and the technical difficulty it moving away from some of these technologies is very high. The added bonus is that a lot of companies that still have this technology also have deep pockets (think financial services and local/national governments).
Another related angle on the cornered resource strategy is also hiring people with particular skills and/or certifications. This might be skills in applications specific to verticals you’re strong in, certifications with specific vendors or even security clearances.
Corned Resource will always be a strong strategy play when combined with Scale Economies, Process Power and Counter Positioning so I expect this to always continue in this industry, however there are several counter-plays that make this type of Cornered Resource strategy less valuable over time. First, is that AI and the rise of hyper-automation - by the time today’s technology has reached the end of it’s lifecycle in 30-40 years time, AI and today’s focus on automation will make some of the skills sets required to understand this technology obsolete and replaced by these higher order systems that are trained on this historical knowledge. Secondly, the continued skills gap in the UK and elsewhere has shocked many organisations into refocusing on growing their own talent pools and re-introducing initiatives like apprenticeships. By building talent in this way, it’s also possible to cross-train in both modern and legacy technologies to bridge this gap and reduce the impact of corned resource.
Process Power
If you ask any person in the IT industry about where they think the best service providers differentiate themselves you’re very likely to get one of two responses: (1) excellent customer service (people vs tickets) and; (2) easy to do business with (buy, onboard, get information, leave). The later of these Hamilton Helmer calls Process Power.
Given that MSPs and GSIs have been in existence now for decades, you’re think that efficient processes and excellent customer service would not only be at the heart of these businesses but that all innovation in this area would now have peaked. Well this is categorically not true, not in the conceptual sense as there is always more things to advance but also not true in an industry sense as in-fact these are areas where organisations are typically failing.
One of the classic critiques of outsourcing is that it’s expensive, not responsive, and that everything is a ticket rather than a human on the other end. I’m not saying that any of these criticisms are invalid, in fact many are quite true. I mentioned previously that excellent customer service is also a strong method of Counter Positioning, but there is also an element of Process Power here too. Behind the scenes of an excellent customer experience is the depth to which you know your customer. Do you know all the customer contacts, their birthdays, and where they have worked before? Do you understand the rhythms of business, objectives and challenges of their organisations? The more information you know about a customer the richer the CRM you have the better the customer experience. Where many service organisations fall over here is that this is something that can be challenging to maintain and keep up to date. This is about integrating a diverse set of knowledge sources (think OSINT) as well as the information gathered from your frontline representatives. The Process Power comes from your excellence in execution of this data maintenance and analytics activity.
If you look at Process Power as a key strategic driver for MSPs and in particular automation and hyper automation then the end state looks less like a professional services organisation and more like a platform provider. Following the recent trends of Platform as a Product it would be easy to forecast a point in the future where the services offered by a managed service provider would be provided through a single platform, engineering transitioning from bespoke delivery to feature engineering and customer experience transitioning to customer success and platform consumption.
Summary
MSPs are often seen using a model, where stability and processes are important and innovation is low. In fact there are a lot of opportunities for innovation, disruption and differentiation within the market. When thinking strategically there are lots of options to transform the industry into something that looks quite different from today, one with high-automation, diversity and great customer experience. I’m excited to be a part of it.