To ASP Or Not To ASP

A whitepaper on the emerging ASP market.

One of the hottest IT trends to emerge in 1999 is the notion of renting enterprise software. Instead of businesses buying, and then implementing and managing software applications using internal resources, they can rent applications, along with the requisite hardware, software and networking components for a monthly fee from a third-party aptly called an Application Service Provider (ASP).

Hosting has generated a significant amount of buzz in the marketplace, based on the premise that it offers a new paradigm for the delivery of IT solutions. Almost every major ISV and IT service provider has unveiled some form of ASP strategy, either by evolving their business model to become an ASP themselves, or by partnering with other organizations to offer application hosting services.

Even technology providers are jumping on the bandwagon. Cisco Systems announced the Cisco Hosted Applications Initiative (CHAI) to facilitate the development of the ASP market. Scott McNealy, chief executive of Sun Microsystems and another big ASP proponent, believes the equipment business will be fundamentally reshaped by the ASP model. "Five years from now, if you're a CIO with a head for business, you won't buy computers anymore. You won't buy software either. You'll rent all your resources from a service provider," McNealy said recently.

The attention on the ASP model has not gone unnoticed in both the private and public equity markets. No venture capitalist today will fund an enterprise application software start-up that does not have an ASP strategy. Likewise, the public markets have rewarded new companies with sound ASP-centric business strategies. Both Breakaway Solutions and USinternetworking had very successful IPOs in 1999, and you should expect to see other private ASPs aggressively pursue the IPO path this year.

The ASP model has its roots in the era of big iron, when the cost of computing power made it prohibitively expensive for most companies to purchase and use mainframe computers. Then, smaller companies would rent time on these machines -- otherwise called time sharing -- from larger organizations or third-party providers. Similarly, the ASP model today is most applicable to small and midsize businesses that have neither the resources nor the staff to support the growing complexity of applications.

As defined by the ASP Industry Consortium - an advocacy group of companies formed to promote the application service provider industry by sponsoring research, fostering standards and articulating the benefits of this new delivery model - an ASP is an organization that manages and delivers application capabilities to multiple entities from data centers across a WAN. The essential difference between an ASP and a traditional outsourcer is that an ASP will manage the application and its components in a central location, rather than on a customer's site. Applications are accessed over a network, and typically are used through a standard web interface. In such an arrangement, applications can be scaled commensurate with demand, upgrades and maintenance can be centralized, and the necessary human resources can be effectively leveraged.

Market Drivers

From the perspective of the end-user, there is no difference whether an application resides inside or outside the organization. From the perspective of the client, the ASP model can be very compelling. First, in the age of the Internet economy, customers are under tremendous time pressure to stay ahead of the competition. An ASP can help customers implement IT solutions significantly faster than having to research, buy and customize applications internally. Second, the scarcity, (and hence expense) of skilled IT resources makes it difficult for most customers to attract and retain qualified staff to support complex IT solutions internally -- the ASP model alleviates the need to build an internal staff. Third, customers can leverage the technology, processes, expertise and economies of scale offered by an ASP to significantly reduce their total cost of ownership. These cost savings can range from 20 percent to 45 percent. And fourth, an ASP provides access to the best-of-breed technology solutions that typically most customers would have difficulty accessing themselves.

From a technology viewpoint, the ubiquity of the web browser along with the emergence of next-generation n-tier applications, where business and application logic reside in the backend server infrastructure, make applications significantly easier to deploy, manage and upgrade. This, compounded with the decreasing costs of hardware, software and bandwidth, make the ASP model a truly viable alternative.

Given these market drivers, the size of the application outsourcing market will be more than $22 billion by 2003, with a compound annual growth rate of 70.3 percent, making it the fastest growing segment of the IT services sector, according to International Data. By contrast, the enterprise resource planning (ERP) business is estimated only grow 19.3 percent over the same period.

Types of ASPs

Due to the frenzy around this market, anyone with a server in their backroom today contends they're an ASP. Forrester Research estimates there are more than 300 providers claiming to be an ASP, with each offering a different story and solution. Some organizations will host the application but leave the ongoing maintenance and implementation to partners or to customers themselves, while others offer a complete soup-to-nuts approach. Not surprisingly, there is much confusion and at times skepticism about ASPs.

Whatever the strategy a company employs, to be a successful ASP a provider needs a strong combination of a) application expertise, which includes consulting, systems integration, application management and support, and applications sales; b) networking expertise, which includes data center, LAN/WAN switching/routing, network management and security services; and c) services expertise, which includes customer service and support, project management, and services sales. These three core disciplines are prerequisite to building a sustainable ASP business.

ISVs, which by definition are application experts, aggressively are pursuing the ASP model as it allows them to go down-market, giving them the ability to address a market segment that cannot afford to buy their products directly. The ASP model becomes a new distribution channel for their products. While some ISVs, such as Oracle, try to implement the ASP model on their own, most are partnering with infrastructure providers that have the back-end service and support structure already in place. However, one issue all ISVs face is they can only offer one solution to the customer, namely theirs.

ISPs, telephony and other infrastructure providers are seeking to quickly enter this market as their traditional connectivity and transport services becoming increasingly commoditized. While they may have the data center/networking expertise and capital, infrastructure providers typically lack in-depth application expertise and thus have to partner with ISVs and systems integrators to provide this capability. AT&T, Qwest and UUnet are all examples of infrastructure providers seeking to enter this market.

Systems integrators, which have the application and services expertise, probably are best positioned to enter the ASP market. However, most of these companies are either not well capitalized enough or, if already a public company, do not want to make the investments necessary to build their own ASP infrastructure at the risk of diluting their earnings. As a result, to enter the market they either partner with or take a minority position in infrastructure providers. A number of systems integrators have announced loosely defined partnerships with large infrastructure providers.

Lastly, there are a number of new providers that have built their organizations specifically designed to serve the ASP market. As mentioned earlier, new breed ASPs such as Breakaway Solutions and USinternetworking, each with a slightly different approach in how they address the market, have been extremely well received in part because of their ability to integrate the three core disciplines into their business strategy. For example, Breakaway Solutions employs a "think-build-operate" strategy, targeting small and midsize fast-growing businesses by offering a holistic set of management consulting, systems integration and application hosting services. Thus, it offers services that can help a customer develop a strategy about how to leverage the Internet to improve their business, build specific custom and packaged e-business applications, and then run and manage these applications on behalf of the customer. The benefit of a truly integrated model is that there is a single point of accountability, hence no finger-pointing between partners.

Pricing Models

ASPs charge for their services based on a monthly fee for a fixed period of time, typically between one and three years. The pricing model today comes in three flavors: 1) a per user/month charge, which can range from $10-$100 for low-end applications to more than $5,000 for complex front or backoffice applications; 2) a fixed monthly fee commensurate with the amount of computing, networking and labor resources required to service and support the application, or 3) transaction-based pricing, where users pay for particular business transactions associated with each application. For example, eGain, a customer service application, charges by the number of e-mail messages serviced rather than a flat fee. For all three models discounts are provided based on the volume of business and the length of the contract term.

Future

Clearly, we are still in the very early stages of this business. While initially driven by the service- provider community, the ASP market is starting to take hold with a growing number of customers using application hosting services, and an increasing number of investments in companies that are betting their businesses on the success of the ASP model. However, the ASP model should not be viewed as a panacea--it is not a solution for everyone. Today, it makes most sense for those customers that do not have the time or resources to do things effectively using internal resources.

As the market and technology matures, we will see ASPs expand their service offerings to include a wide breadth of front-office, supply-chain and back-office solutions. Longer-term, ASPs will seek to take over more and more IT functions within a company as customers see the merits of outsourcing as much as possible. End-users will have little tolerance for ASPs that cannot provide a high quality of service, so there will be an increasing emphasis on the performance (i.e., service-level guarantees) and the track record of the provider. Translated, to remain competitive ASPs will have to ensure they maintain sharp focus and effectively manage the people, processes and technologies employed to deliver application hosting solutions. ASPs also will begin to expand internationally, with an initial focus in Europe, as access to highly skilled technical resources and capital are even more of an issue overseas. Ultimately, there will be shakeout in the market, with the winners being those companies that have well-developed sustainable business models, effective management teams and the confidence of the capital markets.

While there still is much confusion and hyperbole around ASPs, it is clear that this is a business that's here to stay. For those of you who do remember the old days of time-sharing, the advent of the ASP maybe somewhat like going "back to the future."

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