In our growing list of reasons for gross margin compression, the last post covered grading your clients based on how much they demand from your company’s resources. Once you have graded a client correctly, the next question is whether that grade is telling you the truth. If you are certain a client is a C or a D, there are really only two paths forward. Reprice them or end the relationship.
This might be the hardest topic in the whole series. If repricing isn’t going to work, this becomes a breakup. And as the song says, breaking up is hard to do.
Two Ways a Client Becomes the Wrong Client
Keeping the wrong clients too long is a leading cause of gross margin compression, and there are two main ways a client ends up in that category.
The first is that they were never profitable to begin with. The scope of work was priced incorrectly from the start, so there was never a real chance of profitability.
The second is that either they or you outgrew the ideal client profile. We like to think it’s always the client who changes, but the truth is your company changes too. You can outgrow your ideal client just as easily as they can drift away from what you need. That combination, grade plus real profitability, is what makes the case to move a client on.
Owners Don’t Act Because They Are Focused on the Wrong Number
Owners generally know which clients these are, and after grading your clients and comparing profitability, the whole company will know. Determining who and how much is one topic, but the next challenge is making a change.
Revenue is a success metric, a KPI, and a ‘bragging right’ number. Revenue keeps owners holding on to clients they know they should let go. Voluntarily reducing your own company’s revenue is counter intuitive for owners. However, as the saying goes, “revenue is vanity, profit is sanity, and cash is king,” the revenue metric many owners are fixated on does not indicate either the profitability or cash flow. Often that revenue comes at the expense of the margin.
In addition to bragging rights, there are other constraints keeping MSPs from repricing. They include a lack of formal review to force a decision (exactly why a grading matrix matters) and the sunk cost of the relationship history, onboarding effort, and hours your team spent serving this client. There’s also the fear of abandoning a client you’re relationally invested in. These murky relational challenges require numerical objectivity.
Unprofitable vs. Wrong-Fit
There are two categories worth separating here. Unprofitable accounts are priced too low, cost too much to serve, or have drifted since signing. They were never going to work without a reprice.
Undersized or wrong-fit clients are different. They might be below your minimum viable price, in the wrong industry, or outside your ideal client profile regardless of what they pay.
Keeping wrong-fit clients absorbs capacity that could go toward your “A” clients, and this might be the biggest opportunity cost in the whole equation. Every hour spent serving a client outside your ideal profile is an hour not spent growing a relationship with an “A” client. Similar to serving low graded clients, keeping clients outside your company’s vertical threatens morale and turnover cost. Your team spends time learning an unfamiliar industry or working through variables that don’t translate to your ideal client base, instead of moving faster in the verticals you’ve actually chosen to specialize in. That mismatch drives turnover.
Treat Every Client Like an Investment
One of the most useful mental shifts here is to think of each client as an investment in your company. As an entrepreneur, you are investing in the clients you take on. Each one has a price, an expected return, and a cash flow, and grading them lets you see the ROI on that investment. You don’t need extreme detail here, just enough to see the picture clearly.
This is where a buy box comes in, similar to what an investment portfolio manager would use. Set a minimum, whether that’s contract size or monthly fee, and build objective criteria and triggers so decisions aren’t made on a whim. The goal is to remove the emotion from the equation and see the impact of each client on paper.
The revenue and costs (profitability by client from your PSA) from each client are added to their grade to form a full picture. This will provide supporting evidence to relocate some poor fitting clients.
Make a Decision to Exit or Renegotiate
Not every wrong-fit client needs to be fired. Some can be repriced or right-sized, whether that means a reduction in scope or a price that actually gets you to a profitable place. Remember, this is a partnership, not a punitive relationship. The renegotiation conversation should be honest: we are not able to serve you the way we need to at this price or this scope.
When renegotiation isn’t realistic, exiting is the right call, but it has to be handled carefully. How you exit a client says a lot about your professional reputation. A clear notice period, transition support, and a defined handoff to the next vendor protect both the client and your name in the industry.
Many MSPs have had client relationships for decades. Relationships where the professional and personal have blurred together over the years, where they have attended children’s weddings, baptisms and bar mitzvahs. Those relationships are wonderful, and as the owner, you can always choose to keep any client you want.
As this series is about protecting gross margin, some of the hardest, most emotional parts of that work involve clients who may be wonderful people but simply cannot be served profitably.
The goal isn’t to abandon them. It’s to help them find a place where someone else can serve them well, and more profitably, while you protect the margin your own team has worked to build.
At the end of the day, protecting your gross margin sometimes means letting go of a client so both sides can thrive. A fair exit, done with care and clear communication, is not a failure of the relationship. It is the last responsible act of a good one.