The Rule of 40 for MSPs: Why Growth Alone Doesn’t Tell the Whole Story

For managed service providers, revenue growth alone doesn’t tell you whether the business is getting stronger.

An MSP can grow quickly while margins shrink, service delivery becomes less efficient, and new clients consume more resources than expected. On the other hand, an MSP can produce strong profits while growth slows because the business isn’t investing enough in sales, marketing, people, or capacity.

That’s where the Rule of 40 can provide a useful framework.

The Rule of 40 is commonly associated with SaaS companies, but MSPs operate under a very different business model. Rather than treating 40% as a universal benchmark, MSP leaders can use the concept to have a better conversation about the relationship between revenue growth and profitability.

What Is the Rule of 40?

The traditional Rule of 40 combines a company’s revenue growth rate and profit margin:

Revenue Growth % + Profit Margin % = 40% or more

For example:

• 30% revenue growth + 10% profit margin = 40%
• 20% revenue growth + 20% profit margin = 40%
• 10% revenue growth + 30% profit margin = 40%

The concept recognizes that businesses often make a tradeoff between growth and profitability.

A rapidly growing company may accept lower profitability because it is investing heavily in future growth. A slower-growing company may be expected to produce stronger margins.

That framework can be useful for MSPs, but there’s an important distinction.

Why the Rule of 40 Is Different for MSPs vs. SaaS Companies

The traditional Rule of 40 was developed around the economics of software companies.

A SaaS company can often add customers without increasing its workforce or operating expenses at the same rate. Once the software platform has been built, the incremental cost of serving another customer can be relatively low.

MSPs don’t have the same economics.

Managed services may generate recurring revenue, but they are still heavily dependent on people and service delivery.

As an MSP grows, it may need additional:

• Service desk technicians
• Engineers
• Account managers
• Service managers
• Sales and marketing resources
• Security tools and software licenses
• Operational infrastructure

That means adding another $1 million of recurring revenue can have a very different financial impact for an MSP than adding another $1 million of recurring revenue for a SaaS company.

This is why MSP leaders should avoid treating the Rule of 40 as a simple pass/fail metric.

The MSP Growth + Profit Matrix

A more useful approach is to look at revenue growth and profit margin together.

The goal isn’t necessarily to stay in one quadrant every year.

The important question is:

Does leadership understand why the MSP is where it is and whether that position supports the company’s strategy?

Not All MSP Revenue Growth Is Profitable Growth

Consider two MSPs that both grow revenue by 20%.

At first glance, their performance looks similar.

MSP A adds managed services clients that fit its existing technology stack, pricing model, service capabilities, and ideal client profile.

MSP B wins several large clients at aggressive prices. Those clients require additional technicians, new tools, significant onboarding resources, and more service hours than originally anticipated.

Both MSPs achieved 20% revenue growth.

But the financial impact of that growth could be dramatically different.

That’s why MSP leaders shouldn’t only ask:

How fast are we growing?

They should also ask:

How profitable is the growth we’re creating?

High Profitability Doesn’t Always Mean an MSP Is Healthy

The opposite can also happen.

An MSP may improve profitability in the short term by delaying hiring, reducing marketing investment, postponing technology upgrades, or asking its existing team to absorb additional work.

Margins may improve.

But those decisions could also limit future growth, create capacity constraints, or negatively affect service delivery.

Strong financial leadership requires understanding what is driving the margin, not simply celebrating a higher percentage.

Two MSPs Can Hit the Rule of 40 in Very Different Ways

Consider these two examples:

MSP A: Higher Growth

Revenue Growth: 25%
Profit Margin: 15%
Combined: 40%

This MSP may be aggressively acquiring new customers while investing in additional people, sales, marketing, and infrastructure.

MSP B: Higher Profitability

Revenue Growth: 10%
Profit Margin: 30%
Combined: 40%

This MSP may be a more mature provider generating strong margins and cash flow while growing at a slower rate.

Both equal 40%.

But they require very different financial conversations.

The Rule of 40 tells you where the business landed. It doesn’t necessarily tell you why it landed there.

What Financial Metrics Should MSPs Track Alongside the Rule of 40?

Rather than relying on one number, MSP leadership teams should evaluate the Rule of 40 alongside other MSP financial KPIs.

Questions worth asking include:

• What is our organic revenue growth rate?
• How much growth is coming from recurring managed services revenue?
• What is our EBITDA or adjusted EBITDA margin?
• Are gross margins improving as revenue increases?
• What is our revenue per employee?
• Are new managed services agreements being priced at appropriate margins?
• How much service capacity do we have before our next hire?
• Are sales and marketing investments producing profitable growth?
• Are we intentionally sacrificing profitability to support growth?
• If margins are declining, do we understand why?

These questions help turn financial reporting into financial leadership.

How MSPs Can Use the Growth + Profit Matrix for Financial Planning

The Growth + Profit Matrix becomes even more useful when you use it to look forward rather than backward.

Plot your MSP’s revenue growth and profitability for the past three to five years.

Then plot where you expect the business to be next year.

If your MSP is targeting 20% growth, ask what needs to happen financially and operationally to support it.

How many new clients will you need?

When will you need to hire?

What gross margin must you maintain?

How much should you invest in sales and marketing?

How will increased revenue affect cash flow?

What service delivery improvements will be necessary?

Most importantly:

What has to be true for the financial plan to work?

That is where a simple benchmark becomes a strategic planning tool.

The Rule of 40 Is a Framework, Not an MSP Strategy

The Rule of 40 is appealing because it combines two important business metrics into one simple calculation.

But an MSP cannot be managed by a single percentage.

Revenue growth, profitability, gross margin, labor efficiency, pricing, capacity, service delivery, and cash flow all work together.

A combined growth-and-profit figure of 40% doesn’t automatically mean everything is working. Falling below 40% doesn’t automatically mean an MSP is unhealthy, either.

What matters is understanding why the numbers are moving and whether they align with the company’s goals.

At Next Level Now, we help MSP leadership teams move beyond financial reporting to understand what their numbers mean, where the business is headed, and what financial decisions can support sustainable, profitable growth.

Are your financials simply telling you what happened, or helping you decide what happens next?