Compensation best practices for TSPs
Highlights from the Service Leadership Index 2023 Annual IT Solution Provider Compensation Report
For any IT solution provider (TSP), labor costs have the largest impact on services cost of goods sold (COGS) and, often, the largest expense for the business. Labor costs can account for as much as 70% of total business expenses when you include employee wages, benefits, payroll, and other related taxes.1 With so much at stake, do you really know if what you’re paying your employees is at market pay? Or better yet, what are the top performers in your business model paying their employees?
The good news is you now have a resource that will provide you with the compensation data you need to:
- Recruit and retain talent
- Keep you competitive in the marketplace (see what your peers are paying their employees)
- Drive company culture and employee engagement
The recently released Service Leadership Index® 2023 Annual IT Solution Provider Compensation Report™ is the leading source for business intelligence about compensation strategies of top-performing TSPs. This report, which was last published in 2016, was brought back for 2023 based on the high demand for current, industry-specific compensation data, especially due to wage inflation and staffing challenges in 2020-2022.
The 400+ page report gives you total annual earnings (TAE), variable % of TAE, hourly bill rate (for billable employees), TAE increases in 2022 and planned for 2023 for 50+ TSP positions by:
- Three seniority levels broken down by geographic region, city tier, and, where possible, by metro area
- Predominant Business Models™ (PBMs™), also known as business models such as managed service provider (MSP), value-added reseller (VAR), etc.
Unlike other compensation reports, which typically include enterprise IT and other positions only tangentially related to the TSP business model, this report only includes data specific to TSPs. The survey participants were from around the world—Australia, Canada, Ireland, New Zealand, the United Kingdom (UK), and the United States (US). This provided us with a global view of what TSPs are paying their employees and allowed us to provide a look into region-specific and aggregated data.
In addition, because Service Leadership benchmarks the industry’s financial performance worldwide every quarter through the Service Leadership Index®, we can uniquely correlate compensation data to TSP profitability performance. In other words, we can tie compensation to profitability and show how top-performing companies pay differently than lower-performing ones. Let’s start with that.
The most successful TSPs tie more pay to incentive compensation
When we analyzed the compensation and profitability data, we found a significant difference between what and how the Best-in-Class (BIC) TSPs pay their employees versus those in the Median and Bottom ¼ quartile. And we found this correlation not just in the US but worldwide.
The first difference is in what % of pay is tied to incentive compensation standpoint. TSP profitability closely correlated to the % of variable compensation paid for staff and non-owner management positions. For staff positions, the BIC tied 9.6% of TAE to variable (incentive) compensation, while the Bottom ¼ tied only 5.8%. For manager positions, the difference was even more dramatic. In manager positions, the BIC tied 16.9% to variable compensation, while the Bottom ¼ tied less than half of that, only 8.2%.
In both cases, the BIC pay roughly double the proportion of variable pay but even the BIC could do better. Variable pay for junior technical staff should be around 10% of TAE, and for senior technical staff, it should be about 20% of TAE. For managers, it should be 20%-40%. Structuring and managing effective variable compensation is a critical skill every TSP leader needs to learn in order to be successful, as the BIC has shown.
The most successful TSPs also pay their employees less
A common response to learning that BIC are paying a higher % in variable pay is to assume that they are paying more overall. This is due to a widespread belief that more profitable TSPs are more financially successful and pay their employees more. In reality, the opposite is true. More profitable TSPs tend to pay less (lower TAE) for both staff and non-owner manager positions. In fact, across all departments, BIC pay about 9% less than the Median and 13% less than the Bottom ¼ for equivalent positions. Given the impact of payroll costs on services gross margin and sales and general and administrative (SG&A), this is a material factor in how the BIC can attain this level of profitability.
One key way the BIC accomplish this ( for all PBMs) is to narrow their range of technologies marketed and sold by sales, implemented by professional services, and supported by managed services. They also narrow the range of technologies sold and supported by narrowing the range of customer sizes (by user headcount) they will sell to; this is called a Target Customer Profile. These two disciplines materially reduce the number, range and cost of skills needed and thus allow TSPs to staff their teams with a higher percentage of lower-cost employees.
Is wage inflation softening for 2023?
We benchmarked actual 2022 TAE % increases and budgeted % increases for 2023. MSP positions had the second highest TAE increase in 2022 with 36% having an increase of more than 6%, and another 45% having an increase from 4% to 6% (in other words, 81% of these employees received a raise of at least 4%). For 2023, the budgets have these employees receiving slightly smaller increases, with only 20% planned for more than 6% and 61% instead planning 4% to 6% increases. Still, 81% of these employees will receive a raise of at least 4%, but there is a material difference in 36% versus 20% receiving more than 6%.
Interestingly, across all PBMs and all job functions in 2023, there are expected to be significantly fewer employees receiving TAE increases of more than 6% (24% of the population) compared to 2022 (34% of the population). While this does not yet show a return to sub-4% raises (more in line with historical norms), it does indicate a softening in wage inflation.
Why service multiple of wages impacts TSP profitability
The three “legs” of service profitability for all PBMs are rates, utilization, and wages. A fourth leg—efficiency exists in only flat fee firms, which is one reason well-run MSPs can generate higher sustained gross margin %. Because there is no uniform definition of utilization, we can more easily see a service practice’s effectiveness in generating gross margin by measuring the Service Multiple of Wages. This is a simple calculation: divide the billed service revenue for a given period by the taxable wages (W2, etc.) for the same period, whether for an individual or a group. Though the formula is simple, the impact on a TSP’s profitability is pronounced.
A TSP with Service Multiple of Wages of at least 2.5 drives BIC profitability, while a Service Multiple of Wages of 1.9 to 2.0 will be needed to break even (or possibly at a slight loss) on their services business (assuming operating expenses are not also out of line). Below 1.9 will likely lead to a more significant loss.
As the chart above shows, it’s generally not possible to make BIC services gross margin on any service employee whose TAE is above $110,000. As noted earlier, the BIC profitability firms:
- Pay less on average for any given position
- Have a higher proportion of lower-skilled (and lower-paid) staff
- Use a greater proportion of incentive pay within each TAE band
The impact of these strategies underscores the importance of attaining a BIC Service Multiple of Wages (2.5 or higher) for any TSP, regardless of their chosen PBM, to attain BIC profitability and growth.
As you can see, understanding how your peers are compensating and what the top performers are paying is critical in running your TSP. Compensation best practices leveraged by the BIC TSPs worldwide can be applied by any TSP seeking to attain and sustain top-quartile growth and profitability.
To take a deeper dive into the compensation data, including Service Leadership’s analysis, download a complimentary copy of the executive summary. Or if you are to ready drill down into the comprehensive compensation trends in your PBM, your geography and to see how the BIC are compensating, you can purchase the full report here.