Coping with Disaster: Suggestions for Hurricane-Impacted Solution Providers

Our Thoughts and Prayers Are with You

As Solution Providers in southeast Texas, Florida and the southeast coastal states emerge from shelter, begin to take stock and make their first steps towards recovery, we hope to help now – and perhaps provide insight for those unaffected but who may face future disasters. Sadly, Solution Providers have had to face disasters before. The good news is, the great majority have met past challenges and gone on to thrive.

To quote President Eisenhower: “In preparing for battle, I have always found that plans are useless but planning is indispensable.”

Contents

• Our Thoughts and Prayers Are with You
• Family is Your First, Second and Third Priority
• Next, Employees
• Next, Customers
• How Safe Are These Ratios, in Reality, and How Should We Cope?
• What About Merging? What About Valuations?
• In Conclusion

Family is Your First, Second and Third Priority

A family is a remarkably resilient entity but it must have the basics: safety, clean food and water, dry clothing and shelter. The first job of a business owner is to make sure that their own family has these secured. The second job is to provide his or her family reassurance that the future holds good things, that losses happen for a reason we cannot fathom, and that moving forward is the best way to address fears. The third job is, as soon as possible and even if only bit by bit, to return to the normal routines of life or establish new ones.

Next, Employees

As the family is secured, the business owner can turn his or her attention to the next-most important stakeholders: Employees. Employees benefit from much the same process as outlined above for the family: Provide the basics, provide a plan, and focus on returning to normal routines.

Their Families Come First, Too

Make sure all employees are putting their families first. Make sure they’re aware of government and non-profit resources, as well as contacting their insurance companies. Give them time to take care of these priorities, but gradually hold them increasingly accountable (at the right speed) to their work responsibilities. Doing so will help them focus on making practical progress and worry less about things they can’t control. Different personalities cope with disasters differently: Be careful to keep an eye on those who might withdraw as well as those who might “over-volunteer.”

Over-Communicate

A key aspect of leading during times of crisis and stress is to over-communicate. Humans tend to fill in blanks in their understanding with the worst-case scenario. It’s important for the leadership to communicate, communicate and then communicate again. The parents in the family will want to be reassured of things that are normally “givens”:

• I (or my spouse) still have (has) a job;
• The company has activated its disaster recovery plan;
• The company is helping make sure effected employees have what they need to recover;
• The company has the cash and the plan to survive;
• Customer disaster recovery is being scheduled and – as soon as possible – carried out, and any pre-disaster work in progress has been identified and is being rescheduled.

As you communicate, be sure to give calm evidence of good news, while still acknowledging – and updating if necessary – any challenges that remain.

Next, Customers

Obviously, the interest in customers has both practical humanitarian and practical business aspects. We must help our customers return to business, so that they can continue to pay for our services, which allows us to stay in business. In this section, we’ll discuss how customers most often deal with their IT and business challenges during disasters, and how these reactions impact Solution Providers in the most common business models. The broad view is this:

• SLAs are out the window. You’re in triage mode, taking care of the most-damaged or weakened customers first.
• Account for your work. As much as possible, use your normal – or contingency – work recording methods. It’s likely at some point you will need to untangle what you’ve done, and in what order, to continue the later stages of the recovery process expeditiously.
• You may find yourself taking on business you normally would not: more product resale, more time and materials support, more projects. Within reason, this is fine. The urgency of recovery is more important than business model strategy, as least for a short period.

Cash is King, for You and for Your Customers

Limit free or heavily discounted work to the amount you might donate in an extreme charity situation.

This is obviously difficult to do; the instinct for altruism is admirably strong, but it needs to be tempered with enlightened self-interest. You need to have positive cash flow to pay employees so they, too, can recover. You also need it to help other customers recover.

This is a delicate balance you should try to keep quietly and carefully. Some customers may not be able to pay at their normal speed; some may fully intend to pay but later find they cannot. Point customers to where they can get business assistance – don’t be a bank. You may want to seek business assistance, too.

How Much Cash is Enough?

In our Service Leadership Index® benchmarking – the leading confidential benchmark of IT Solution Providers worldwide, we track two ratios that can help you understand the resilience of your cash position:

• BSR8. Cash Safety Ratio – Months Covered: This is your current cash and A/R divided by your known expenses. Known expenses include: All Cost of Goods Sold (COGS) payroll and contractors and all operating expenses (excluding depreciation and amortization). Not included are product COGS for non-recurring products (such as hardware and traditional software), because these costs don’t occur unless you have an order. This gives you a picture of how many months you could cover all your foreseen expenses even if no Revenue came in at all. (Granted, this is an unlikely occurrence, but the ratio is a good comparable and an indicator of safety in a worst-case scenario.)
• SR16. Recurring Revenue Expense Coverage: Even recurring Revenue is under some pressure when geographic disasters occur, but this ratio can provide an idea of what the immediate monthly invoices, and therefore Accounts Receivable (A/R), could be and – ideally – should be. This ratio is similar to the one above, but calculates the proportion of each month’s known expenses paid for in advance by the Monthly Recurring Revenue (MRR) invoices that go out at the start of the month. A higher ratio is safer (assuming your recurring Revenue lines of business are profitable): If your ratio is 100%, for example, then 100% of your known expenses – as defined above – are paid for with MRR.

We do report the BSR8 – Cash Safety Ratio for the Best-in-Class (top quartile adjusted EBITDA %) firms:

• It is 3.7 months for Infra-MS PBM firms (MSPs).
• It is 5.1 months for Product-Centric PBM firms.

However, in the results of each company’s Service Leadership Index Benchmark Report, we do not stoplight the BSR8 ratio. The reason for this, is that this ratio is a judgment call based on strategy and risk tolerance. It’s not by chance that the BSR8 ratio above for the Product-Centric firms is nearly 40% longer than it is for recurring-Revenue-centric firms. Product-Centric firms, if they’re good at forecasting their business, can “see” 50% to 75% of their Revenue perhaps as much as 45-60 days out.

MSPs who are good at forecasting, on the other hand, can reliably predict 50% to 75% of their Revenue as far as six months out, and perhaps farther.

We can see this in the Best-in-Class ratios for SR16 – Recurring Revenue Coverage:

• It is 78% for MSPs, i.e. 78% of their total monthly expenses (excluding product COGS) are covered by the month’s recurring Revenue,
• It is 44% for Product-Centric firms.

Product-Centric firms have less forecast visibility and less of their expense load covered by recurring Revenue. As a result, they prudently keep more cash on hand.

What About the Impacted Regions?

To understand what cash position the Solution Providers in the impacted regions might be in, we analyzed the BSR8 and SR16 ratios for the impacted states, and within those, the impacted telephone areas codes. This includes all areas codes in Florida, Georgia, and North and South Carolina, and the southeastern area codes of Texas.

In the charts below, we also show the average ratio for the entire United States (including the impacted regions) for comparison.

BSR8 is probably the more important ratio – again, cash is king.

Thankfully, whether we look at Managed Service-Centric firms or Product-Centric firms, those in Florida and Texas, where the impact was the harshest for the most people, the Cash Safety Ratio is higher than the U.S average. The same is true when considering only the impacted area codes of Texas (and all of the four other states).

That said, unfortunately, the BSR8 ratios for Georgia, South Carolina and North Carolina, are lower than the U.S. average and considerably lower than Florida and Texas.

The picture is much the same when looking at SR16 – Recurring Revenue Coverage of Non-Product Expenses:

• Florida MSPs score above the U.S average with over 90% of their non-product expenses covered by their recurring Revenue.
• The impacted area codes of Texas (not shown separately on the charts) also scored high, with 89% versus 82% for the non-impacted area codes of Texas.
• These compare to 86% for the U.S average MSP.

However, when looking at Product-Centric firms, only those in Florida have a Cash Safety Ratio higher than the U.S average. Not even the Product-Centric firms in the impacted area codes of Texas are above the U.S. average.

How Safe Are These Ratios, in Reality, and How Should We Cope?

We can surmise from this analysis that the average Solution Provider in the impacted regions is reasonably safe in terms of cash and A/R, and in terms of the degree to which their expenses are covered by their recurring Revenue.

But, that is only true if the A/R is collectable and if the amount of recurring Revenue to be invoiced, doesn’t drop. Based on past experience, here is what we expect for the Immediate future, for those firms in the Infra-MS (MSP) and Product-Centric PBMs.

Immediate Coping Factors for Infra-MS (MSPs)

 In emergencies and economic downturns, MSPs generally experience an MRR decline of between 5% and 20%, for all the reasons noted above. That said, some percentage of MSPs go out of business or weaken to the point that they cannot serve MRR customers, and those “orphan” customers seek out new MSPs with whom to contract.

Similarly, as customers realize that on-premise systems (likely) had the longest downtime, we will see added momentum to the flight to the cloud. As top-performing MSPs know, this means an increase in Managed Services Revenue as the customer goes to the cloud.

If you were in the business in 2001, you may recall that, in the SMB space, the modern backup and recovery era was struggling to get started. Many SMB Solution Providers had developed BU/DR offerings that were more reliable and effective than the then-current plague of tape backup systems, but most could not convince clients to try them

Sadly, the region in which the initial adoption first spiked was the New York / New Jersey / Connecticut area in the months after the September 11 attacks. This momentum spread to the rest of the country over the course of the next few years. This BU/DR effect – and a less pronounced but corollary effect to be more likely to buy Managed Services and, more recently, cloud – has followed each major disaster (thankfully almost all naturally occurring) since then.

Immediate Coping Factors for Product-Centric Firms

In disaster situations, many – but not all – of the patterns for Product-Centric firms are the same as for MSPs. There are significant differences; we cite just the differences or points of emphasis in the table below. Hence, we suggest Product-Centric firms read the above table for MSPs, as well.

In emergencies and economic downturns, Product-Centric firms, unfortunately, have a harder time surviving than do MSPs. In the downturns of 2001-03 and again in 2008-09, the failure rate of Product-Centric firms was about 20% versus about 10% for MSPs. Meanwhile, those who survived experienced Revenue drops of 20% to 50%, while MSPs saw Revenue drops on average of about 10% to 20%.

We are encouraged that the BSR8 ratio is higher for the average Product-Centric firm than for the average MSP; they need the extra safety.

What About Merging? What About Valuations?

Some Solution Providers who are experiencing undeserved stress from these massive disasters, may consider merging or selling to stronger firms in the region, or to firms outside the region who have expressed or start to express interest.

For some, this may be a path preferable to either going out of business or experiencing a prolonged recovery period without additional resources. This is generally the case after such geographic tragedies. The increase in mergers and acquisitions typically starts soon after the disaster and goes on for a period of 12-18 months.

Obviously, feeling you have no alternative but to merge or sell, is not a good feeling. On the other hand, it is certainly good to have the option if needed, and may be the most beneficial path for the owners, the employees, the vendor partners and the customers.

The ins-and-outs of mergers and acquisitions are too complex to undertake a full discussion here. However, we can provide some key suggestions for investigating this path in an urgent situation.

Valuations and Deal Structures in Distressed Situations

The typical distressed situation is that the economy (local and broader) is in reasonable shape, but the specific Solution Provider has not managed to create a successful path. In the case of disasters, this may or may not be true, but the distress is compounded greatly by the softness of customer behavior we have discussed above.

This – and the often-urgent timelines to execute the merger or acquisition – tend to push values down. The seller may also want more cash up front, and this, too, tends to push overall values down.

The seller is generally not in the optimal position to negotiate, because current and near-term business results are likely to be sub-optimal. Nevertheless, the seller is usually not inclined to take deals he or she perceives as one-sided; nor do such deals usually work out for the buyer, long term.

The parties may want to consider a longer than average earn out (say, 2-3 years versus the usual one year). The earn out might be based on Revenue from existing accounts and those companies on the seller’s prospect list that were not on the buyer’s prospect list. This gives the seller the maximum upside while still managing risk for the buyer.

At the same time, it leaves most of the profit factors in the control of the buyer. This is usually good. The buyer usually doesn’t want to give the seller the level of responsibility in the post-merged company, that the seller would logically ask for if more of the earn out was based less on Revenue and more on Gross Margin or bottom line profit.

Keep in mind the value of doing a good job of mutual qualification, even under shortened timeframes.

To ensure the highest likelihood of customers coming over successfully for the long term, before the deal is framed up:

• Take five of the sellers typical (not largest or smallest) customers, and price them on the buyer’s pricing model, (no customer names needed). Then take five of the buyers typical customers and price them on the seller’s pricing model.
• If the seller’s customers are priced higher, there is a good chance they will come over and be profitable for the buyer. The buyer may even be able to raise prices more easily on their own customers.
• If the seller’s customers are priced lower, there is a materially lower chance they will come over to the buyer’s company, be profitable, and stay. And, the buyer may find his or her staff questioning why the buyer’s pricing is “so high”.

In the latter case, it would be wise to not do the deal.

Similarly, compare the Target Customer Profile (size range) of the buyer’s and seller’s core customers. If they are materially different, don’t do the deal. This is true even if the buyer or seller thinks adding a new Target Customer Profile is a good strategy. Even in the best of times, it’s not.

Lastly, within the bounds of common courtesy, buyer and seller should try to avoid the temptation to treat each other with kid gloves during the negotiation. Successful working relationships are possible when the two parties disagree, work it out, and are still able to come to work the next morning and feel ok about the result.

The best time to determine whether that’s likely to be true in the future, is now, during the deal negotiation. Be frank, be direct and communicate authentically, now, as you negotiate the deal. Find out what the other person is like.

In Conclusion

Our hearts and minds are with the Solution Providers in the impacted regions, and their families. The scale of these disasters is mind-boggling, so the best strategy is probably to focus on your immediate needs, in your immediate area, and take it step-by-step. Celebrate the small victories and look up, when you can.

If we can be of any assistance, please, as always, feel free to reach out to us at paul@service-leadership.com or brian@service-leadership.com.

Notice: The terms and concepts of SLIQ^™, Service Leadership Index^®, (S-L Index™), Predominant Business Model^™ (PBM^™), Operational Maturity Level^™ (OML^™), Normalized Solution Provider Charts of Accounts^™ (NSPCoA^™), Total Cost of Managed Services^™ (TCMS^™) and Service Factory^™ are proprietary to Service Leadership, Inc. All Rights Reserved.

¹ A “Likely to Pay” score based on such things as: What they’re committing to pay and when and if they do, observations of business health by your techs and sales people when on-site (be subtle in how you ask your people for this), speed with which recovery product and projects are requested and how they are funded.

² Fewer devices covered, fewer users, lesser SLA, lesser scope and/or outright discounts.