When a Solution Provider asks us if and how to open a new location – whether it is their second, third, fifth or tenth – we ask: “What are the goals of the shareholder(s), which have led to considering opening another location?”
The answer most often is, “Growth” although it can also be, “Because our current clients here, have remote offices there.” In that case, there are two purposes:
In either case, opening a new market is an investment and a risk of nearly the same magnitude as starting a new business or making a venture capital investment. It has the potential to create significant additional value, but there is a high risk that it may not, even after significant investment and time. Even large and consistently successful Solution Providers do not open new markets lightly; the failure of a new market can be grounds for senior heads to roll.
In this newsletter, we’ll examine the pros and cons of opening a new market, how to make the decision, and how to mitigate risk. We’ll also outline the best practices for opening and operating the additional location.
Throughout this newsletter, we’ll use Managed Service Providers (MSPs) as our example. However, the best practices cited here apply to Solution Providers in any of the Predominant Business Models™.
In terms of risk and reward, the decision to open a new location is about on par with the decision to buy a company, or to make any other large – possibly “bet the farm” size – investment decision.
Therefore, it merits looking at with a critical eye.
You may wonder if one reason we look skeptically at the prospect of adding locations might perhaps be because we ourselves have not been successful at adding new locations. Rest assured:
Some of those plays included buy-side M&A ranging from a few to a handful of deals. Others were M&A-heavy: many sequential acquisitions and integrations. Thus, some new locations we opened were “greenfields” (opening a new office without an acquisition), but others included an acquisition.
We know firsthand the challenges and best practices of opening and operating new locations. We also have seen many attempts by other Solution Providers, including those who later became our clients, at opening new locations which did not go well.
From this experience, we encourage you to examine your reasons and assumptions with a critical eye. Since you may not have that experience, we will provide at least some of the critical eye for you.
Unfortunately, the decision to open a new location is often a case of “the grass is greener.” We can dispense with this false assumption quickly:
These blunt observations may fail to convince the congenitally stubborn and incurably optimistic entrepreneur, so let us examine them in more detail.
How many MSPs are there? In our master database, we have about 34,000 substantive Solution Providers (across all 10 Predominant Business Models), about 80% of whom are in the United States. CRN will tell you they have about 100,000 subscribers in the U.S. Microsoft will tell you they have about 320,000 partners in the U.S. (and another 80,000 worldwide).
Notwithstanding the likelihood than only about 40,000 or so of these U.S. Solution Providers are substantive – larger than 2 or 3 people – these numbers all make the same point:
This puts the number of companies in the U.S. who are materially in the MSP business model at something like 10,000 – 15,000, a number which ties out nicely with the approximate combined license base of the top three Professional Services Automation (PSA) tool vendors.
Example: Recently, for a Private Equity client looking to buy an MSP in what would generally be described as a Tier 3 market (i.e. not in the top 40 markets by population), we found 113 substantive Solution Provider companies of which MSPs made up – you guessed it – about one-third.
In short, there are no underserved markets, at least in terms in number of Solution Providers.
The point being, if the competition in your city is stiff, and you feel you’re running out of leads, keep in mind your peer Solution Provider in the “new” market is likely feeling the same way.
Think about it: If you go to a lot of industry events, you’re probably aware of more competitors in your market than most. Yet you probably can name only a half-dozen or so, and you probably actively compete with fewer.
If you operate in a Top 20 metro by population, our master database will record at least 500 companies there, and perhaps a thousand or more. If you’re in a Tier 3 market there are generally at least a hundred or so, and that’s ignoring the phenomenon we call “Tier 3 Titans”.
The fact that there are so many Solution Providers in your current market, is good news for you, and there are several reasons why.
The fact that there are so many Solution Providers in your market is good because it means there are many customers! Let’s take MSPs, for example.
This can be seen in the chart below.
The meaning of this chart is that, not only is the dreaded “commoditization” not occurring, but also that there has been a massive, and mutually beneficial, expansion of the number of SMBs and mid-market firms buying Managed Services.
It also means that if you use the proper operational methods – as we say if your Operational Maturity Level™ is high – you can make great money, just as the top quartile always have!
Which brings us to our next point.
It’s no harder – though it is cheaper, quicker and less risky – to “re-break into” the market you’re already in again, than to break into a different market.
If you’re seeking a new market because growth or profitability has stalled out, taking your current less-than-optimal growth and profit tactics into a new market – where as we have seen the competition is just as stiff – is not likely to produce a different result.
Let’s look at the decision-making of those who successfully operate true multi-location Solution Providers – that is, those with 10 or more locations and who have Median-or-better profitability and are growing at the whole-company level.
These executives are accustomed to being persistently badgered by those of their General Managers whose locations are not performing, to be given permission to open a new location: “My market is tapped out. Let me open another location,” says the under-performing GM, “Then I’ll be profitable.”
The executives of successful multi-location companies have a common response to this (usually heartfelt and desperate) request: “Fix the model, then expand.”
The great news is, by becoming more operationally mature, the low-performing managers also can succeed in their current markets! They just have to acquire the best practices and put them to work!
The successful multi-location companies know this because if the current, failing General Manager sadly cannot improve, and he or she is replaced by a General Manager who is more operationally mature, the same “terrible market that cannot be turned around” is in relatively short order, made into a successful one.
Once you have fixed your profit model in your current location(s), there are several conditions under which opening another location might then be a good idea:
You will notice these are a series of “and” conditions: They all need to be true for opening a new location to be a good idea.
To proceed without all three being positive, is likely putting the organization itself at material risk. It also indicates that you likely do not have sufficient resources – time, money, people – to help the new location succeed.
What is the growth potential in your current market, for the operationally mature Solution Provider? We ask this question now, because we’d advise you to analyze your current market to understand how much opportunity you already have for growth, without the risk and expense of opening a new location.
Obviously, you can also use this analysis on a potential new market, if you have met the conditions we have cited above, for considering opening a new market. The potential for growth in your current market (or a new one) is pretty easy to figure out.
The U.S. Census Bureau counts not only people, but businesses as well. Each year, they publish detailed spreadsheets showing the number of businesses (and offices, since many businesses have more than one office) in the top 40 markets (“Metropolitan Statistical Areas”, as they call them) as well as dozens of what they call “Micropolitan Statistical Areas”. They break out the count by number of businesses (and offices) with:
(To find the U.S. Census data for your specific geography, go to this page: https://www.census.gov/data/tables/2017/econ/susb/2017-susb-annual.html and scroll down to Metropolitan Statistical Areas (MSAs). Most other nations have similar census data.
Obviously, this is accurate enough for SMB and lower-mid-market business planning. But it gets even better: They also break these down into vertical markets. It’s useful data galore! Best of all, you already paid for it.
Of course, not all these businesses are ripe for great services and solutions. Remember that high OML™ Solution Providers (i.e. the ones in the top quartile of growth and profit) only pursue customers who want the “full meal deal”, an offer which appeals to about 25% of the client decision-makers in any given market.
However – and this is why the high OML pursue them – these uncommonly smart decision-makers each spend on IT about 2x to 5x what each of their more common but less-smart peers do.
By focusing on these smart decision-makers, the high OML:
Thus, you have to take the Census Bureau data and reduce it by about 75%. Thankfully, there are so many SMBs and mid-market companies that there’s plenty to go around even in targeting only the “smart 25%”.
As an example, let’s focus on the SMB space, and on Managed Services1, and use Louisville, KY, if only because it’s the 30th largest metro in the country, putting it squarely in the middle of Tier Two:
As you can see, the Census Bureau says that in this market:
Yes, the 1,357 smart SMB decision-makers in this market are indeed spending about $142mm on IT infrastructure products, projects and operating services, each year.
The average MSP in 2017, remember, was about $4.7mm in Revenue. That means the average MSP in this market:
In our master database, we show nearly 200 IT companies in Louisville. If we “scrubbed” the market on behalf of a buy-side M&A client or Private Equity group, we would probably double that number.
Should our fictional, Louisville-based MSP – who wants to accelerate growth – open an office in, say, Lexington? Lexington is 78 miles or 1 hour 22 minutes from Louisville, as Google drives it.
Lexington is a smaller town, yes, but a smaller town means less competition, right?
Well, no. Our master database shows nearly 60 IT companies in Lexington, and again, if we researched it, we could probably double that. And here’s what the Census Bureau says about Lexington:
There are about 40% as many SMB establishments in Lexington and – no surprise – about 40% as many IT companies, as in Louisville.
Lexington is no more underserved than is Louisville. Given that the competitive landscape is about equal, why would our fictional Louisville company risk the expense and distraction of opening an office in Lexington when they only have 3.3% market share in Louisville, a market they know much better and which knows them better?
Does our fictional Louisville company think that somehow the MSPs are less capable (i.e. lower OML) in Lexington and therefore easier to beat? Again, the Service Leadership Index says “No”. No geography has a materially disproportionate number of higher or lower OML players.
But if our fictional Louisville company is truly, say, an OML 4.2, why not go trounce the lower OML guys in Lexington? Because, of course, there as proportionately just as many low OML guys in Louisville to trounce!
Now, the Private Equity guys love to invest in companies which take advantage of what is called “The Law of Large Numbers.” Meaning, they would prefer to buy a company which is profitable and growing fast but which has, say, only 0.33% of the TAM instead of 3.3%. This is because they know how hard it is to win and keep market share.
Therefore, they might look at the 3.3% market share our fictional Louisville MSP has, and say, “Well, 3.3% is a large proportion of the market, so it’s pretty hard to get to 10% share, so I don’t want to be there.”
That’s a correct opinion when you have hundreds of millions to invest, across multiple investment plays, more or less at whim.
But it’s irrelevant to the MSP owner who wants to get to $10mm and do it essentially on cash flow. Private Equity guys play “win or bust” and go for $200mm in Revenue by spending gobs of someone else’s money. The MSP owner doesn’t often play that way, and rightly so.
The fact is, the “smart 25%” of decision-makers, want the full meal deal and they want great service, and they’ll pay well to the high OML companies that can deliver it.
The results say this strategy wins more than its fair share of the market, in any metropolitan or micropolitan area, in any country, on any continent.
Let’s learn how to successfully open a new location, by looking at what normally succeeds and normally fails.
A critical lesson for opening new locations is to note one of the key reasons our first location succeeded: The principal (the owner, you) was located in that town.
Like most IT Solution Provider owners, you’ll roll your eyes at this one and say, “Oh no, I can’t be everywhere. That’s not scalable!” That’s true (and it’s solvable through another best practice we call “Principal-Led Selling”, not the subject of this paper).
But let’s look at why principals (owners, you) are so effective at selling, and why (without the principal-led selling model noted above) that success is so hard to replicate with a sales team.
In all markets, targeting any customer size, by any Solution Provider size, IT services and solutions are best sold – most safely and with the most value for both parties – C-level to C-level. Why?
Because IT solutions (products plus the services to implement them) and services (operating services like break/fix, Managed Services and Cloud services) are intangibles. Professional services and support services are not manufactured items which come from a literal factory and are received at the customer’s literal loading dock.
Instead they are the craftsman-like efforts of skilled people who are attempting to meet the customer’s often poorly expressed needs, too often poorly interpreted, and which to be successful often require desired but unpredictable behavior changes from the customer’s employees and executives.
In addition, the smart customer decision maker knows they (and their people) are not well-qualified to determine whether or not you have the technical acumen to successfully deliver the solution or service.
As a result of these two factors, the smart customer C-level knows that the decision of who to go with for a new solution or service, largely comes down to trust. Specifically, trust between themselves and their peer C-level in the Solution Provider company.
Given that, let’s now look at the sales cycle for these intangible solutions and services through the smart customer decision maker’s eyes, in two scenarios. First, with you, the principal/owner, as the lead salesperson and second, with a good (though not rock star) sales rep leading the sale.
First, with you (the owner or principal) leading the sale:
This is a very efficient sales process for both of us. It is as fast and as safe as it gets in the intangible world of IT solutions and services.
Now let’s look at it the second way, where you approach my firm with a good (though not rock star) sales rep.
Five short, simple steps as compared to six or more convoluted, lengthy ones. If you’re sending in a sales rep, but the owner of your competition meets me at a community charity event, you are probably going to lose.
(A rock star sales rep may overcome these obstacles, because they immediately demonstrate an above-average or high degree of understanding of my business, which helps me feel more comfortable that your solution or service might be well-suited to me, and they have an above-average degree of gravitas, presence, personal persuasiveness – whatever you want to call it – that convinces me that they can in fact carry out within your firm, what they have committed to me. Those are rare reps.)
Meanwhile, back at your office, you (the principal, the owner) are indeed commanding the troops to deliver what you – in our short, effective, brief interaction – have committed to doing for me. And you are keeping people, process and tools aligned so that you can continue meeting that commitment and make a fair profit, which I want you to do.
This is why your first location was a success: You (the principal, the owner) were (and are) fully engaged with prospect and customer decision-makers in over and over in the shortest and most efficient sales cycle possible.
The point, of course, is that second locations rarely succeed unless there is someone who can act in the principal role, full time, physically, in that location. In that new city, the C-level decision-makers who are smart, want to meet that person before they make a buying decision. Conversely, the customers in that market who are willing to make a buying decision without meeting a principal, are likely not smart enough about IT to make good customers.
There aren’t enough principals in your company to have one in every location, and in many cases, it is not wise to add more principals. We’ll solve this in a moment.
Contrast this with the most common method of opening a new location:
If the rep is a self-starter and has a high activity level, then at least appointments will begin to happen. They will be unlikely to be with C-level any time soon, but eventually some will be.
As noted above, however, the customers who are willing to buy without meeting your C-level, and also to buy from a company new to town, are unlikely to be smart enough about IT to make good customers. In addition, most sales reps are not good at effectively communicating to prospects what you can do well or at communicating to your team what they have committed to.
As a result, efforts to deliver quality with controlled COGS and sales cost, are likely to be hampered. Without quality, referrals do not come, and the sales rep will lose confidence, the death knell of future sales.
If the rep is not a self-starter and is not good at generating meeting activity, well, we know that outcome.
These are the reasons the typical approach to opening a new market do not work.
Based on the lessons we can take from your initial success in your first market, and from those who have succeeded in opening and operating new markets, let’s outline the rules for opening a new location.
If you abide by these eleven rules, you’re not guaranteed to be successful in establishing a new location, but you’re more likely to be. These are the methods used by those who have most often succeeded in the past.
There are further nuances to evolving a successful multi-location operation – matrix management, proper P&L structure and allocations, career pathing, centers of excellence, incentive compensation, and so on – but following these eleven rules will get you off on the right foot.
We’ll close with a couple of examples of Solution Providers who got it right.
In this first case, the Solution Provider got it wrong and then applied more of the rules above and got it right.
The two owners had known each other since childhood and built the business together, starting with two locations in two cities about a 90-minute drive from each other. They were equal owners, and one lived in one city, while one lived in the other. One had sales and the strongest leadership skills and the other had the best process and financial management skills.
So, they immediately, out of luck, good instincts and/or strong understanding, met the requirements of Rules 1, 2 and 6:
Over time they developed an implicit understanding of Rules 4, 7, 8 and 9. They understood that one location’s success meant success for the other, that back office functions could only be built in one location, that new offers had to be developed such that they would work in both locations, and that the company must engage in thought leadership marketing equally in both cities.
They became successful and wanted to extend that success to other markets.
They decided to mitigate their risk by buying a company in a third market, which had existing Revenue, instead of opening a greenfield operation. There is nothing wrong with going the acquisition route, as long as the eleven rules above are applied.
However, once the acquisition in the third city was made, things did not go well. They purchased a company about 1/10th their Revenue size, which was prudent. However, several factors mitigated against success:
Although barely profitable when they bought it, the location quickly fell into negative profit after the acquisition, because the former owner, now location manager, struggled even harder under the additional responsibilities of interfacing with the new company and adopting new (mostly undocumented) methods and offers.
On about $3mm in Revenue and virtually no growth, the newly acquired location then posted a series of years in which it lost between $300,000 and $400,000 at its bottom line.
The two original locations of the company, thankfully, continued to grow and to make good profits, so the losses at the third location were sustainable but highly undesirable.
The owners didn’t want to shutter it yet, so something had to be done to fix it.
The alert reader will have diagnosed the four bullets above and spotted violations of all or part of Rules 1, 2, 4, 6, 8 and 9, and possible violation of Rule 3. The company may have been in compliance with Rules 5, 7 and 10, and Rule 11 didn’t really yet apply.
The owners came to realize this, and also correctly came to realize that the single biggest challenge was correcting the violation of Rule 1. If the issue of physical proximity could somehow be resolved, then the other rules could more effectively be met.
The third location could not productively be physically moved closer to the other two locations. Also, the third location and one of the two original locations were in Tier 3 cities which could only be flown directly from one location. So additional airfare, even if tolerable, would not satisfy Rule 1 for the owner in the Tier 3 city. He could not get to the third location in one day and get back.
The solution, happily, came in the form of satisfying one of the owners’ long-time desire to learn to fly as a hobby. He was the one with the stronger process and financial acumen, and so served as the company’s CFO. As such, he was keenly aware of cost, and was sheepish to admit not only of his long-time interest in flying, but to assert that the high cost of buying and operating a private plane might actually have a business benefit.
Nonetheless, they took the chance and bought a used, pressurized, twin-prop plane, and he started to learn to fly (on his own time of course).
Meanwhile, they immediately took two steps to get benefit from the expense. First, they arranged to hire a pilot and charter out the plane every Tuesday, Thursday, and weekend the owner/CFO wasn’t using it. This, to their great pleasure, covered the expenses of owning the plane.
Second, they retained the pilot to fly a rotation between the three locations every Monday, Wednesday and Friday morning and evening. This allowed not only the principals to easily and nearly spontaneously meet Rule 1, but also to start a critical rotation of pre-sales engineers, billable people, administrative and management resources, to circulate fluidly between the locations, bringing the full benefit of the company’s resources to the previously isolated and starved third location. Some of the third location’s few key engineers were even called on to support sales and deliver work in the two original locations!
Immediately, Revenue in the third location started to grow. Commonality of offers, methods and practices improved, creating further leverage. The average size and richness of deals in the third branch started to grow towards that attained by the two original branches. Training, job rotation, career pathing and planning meetings all increased in frequency and effectiveness.
In the first year after the plane was purchased, the third location attained a $300,000 bottom line profit, after having lost the same amount the previous year. This represented a $600,000 positive swing to the company’s bottom line, from a $250,000 investment in a good used plane.
At the end of that year, the CFO asked us if we thought they had made a good decision in buying the plane. He knew that the cash flow impact had been strongly positive, but he wanted an outside, objective opinion. Obviously, our answer was, “Yes!”
It didn’t hurt that we also reminded him that every cash flow dollar resulted in (at the time) about a 6x increase in stock value. So, the $600,000 improvement in cash flow also meant an increase in company value of about $3.6mm (net of the cost of the plane, of course, which could be resold at any time).
Here’s to fulfilling long-held desires for hobbies! And here’s to following the eleven rules for safely opening and operating an additional location.
In this case, the Solution Provider had only been founded a few years earlier but shown strong growth from the start. The founder in this case was already near OML 5; he was past 70 years old and was recently retired as head of worldwide professional services for a $90bb IT equipment manufacturer, a household name. That alone would not necessarily make one OML 5, but in his case, he was.
Having to retire from his life-long employer didn’t mean, however, he had to retire from the IT services business. He started his own company, on a shoestring, but after only five years, he was at $25mm in services and growing quickly and profitably.
He was operating in four cities. In reviewing his choices of geography, which were not typical, we asked, “What demographic or economic analyses did you do, to arrive at these choices for office locations?’
He said, “I don’t do any analysis, beyond making sure the market isn’t farther away than I want to travel in a day.
“I just go looking for someone who has built a small IT company – say, $4mm to $5mm in Revenue – and sold it. Someone who can do that, I can teach. I just look until I find one that wants to learn from me, wherever they are, and I hire them as principal in charge of whatever city they’re in.
“I turn them loose, and I teach them how to run the business at the next level, and the next one after that.”
He followed Rules 1, 6, 7, 8 and 9. Most important of these, was Rule #6: Someone Must Be in Charge. The ingenuity of his approach is that he sought and hired people who had proven they could build a business at least once.
As always, it comes down to the leadership.
Service Leadership is dedicated to providing total profit solutions for IT Solution and Service Providers, directly and through industry consultants and global technology vendors. The company publishes the leading vendor-neutral, Solution Provider financial and operational benchmark: Service Leadership Index®. This includes private diagnostic benchmarks for individual Solution Providers and their business coaches and consultants. The company also publishes SLIQ™, the exclusive web application for partner owners and executives to drive financial improvements by confidentially assessing and driving their Operational Maturity Level™.
Service Leadership offers advanced peer groups for Solution Providers of all sizes and business models, and individual management consulting engagements for Solution Providers from US$15mm to US$3bb in size worldwide. In addition, Service Leadership provides global technology OEM with advanced partner enablement assets, partner ROI models, management consulting and advanced peer groups, as well as executive and industry best practices education and speaking. Please visit www.service-leadership.com for more information.
Notice: All materials published (electronically or print) by Service Leadership are proprietary and subject to trademark and copyright protections, regardless of where and how it is sourced. 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 However, the same analysis that applies to MSPs also applies to Product-Centric and the other eight Solution Provider Predominant Business Models.
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