Biting off more than they can chew - Industry Trend or Event

When the applications service provider market first emerged it seemed specialist companies were set to feast on serving up a range of software to hungry businesses. Now players are having to think more carefully about how their models fit in with customers' needs, and where they sit in the ASP value chain.

The applications service provider (ASP) market is enduring harsh growing pains.

The promise of huge revenues from corporate users outsourcing their applications has yet to emerge, and companies, many start-ups born from the early wave of optimism, have been forced to retrench their activities and realign their strategies just to survive in what many now see as an over-served market.

This reassessment has resulted in the emergence of two distinct markets in the United States and Europe (see box, p.25) as ASPs strive to provide services more in line with market needs.

At the same time, analysts are still predicting lucrative business for ASPs in the future. Cambridge, England-based consultancy Analysys Ltd., for example, predicts the global ASP market will be worth more than $82 billion in 2005, of which about $25 billion is expected to be accounted for by the U.S. market.

The main debate in both regions now, given the new market realism, is not so much whether there is still a demand for services from ASPs, but what kinds of companies are best equipped to provide those services, and the best way to go about doing it.

"Over the last 12 months the view on what is an optimal ASP model has evolved away from pure-play ASPs." claims London-based Stuart Keeping, vice president, global marketing, Cable and Wire less a-Services, of Houston, Texas "Some companies have a lot of in tellectual property invested in the model but don't have the funding because of slower than expected growth. They also don't have the breadth of reach or brand equity necessary to penetrate the market, so they are moving to become en enablers of ASPs," he said. "It's a son of consolidation. It's a resegmentation of the value chain."

Bigger does not mean better

But, according to some analysts, it's not necessarily the case that bigger, established players are best positioned to win out, even given their existing customer bases and brand advantage.

"It's still a viable business model," says John Delaney, senior analyst at Ovum Ltd., London. "Some operators have very strong capabilities in some sectors, such as mobile operators with messaging. However, as a general proposition it's inaccurate to say larger operators are in a better position across the board [to provide ASP services] than smaller companies."

In fact, recent research demonstrates there is still plenty of new business to be had from the market. Zona Research Inc., in Redwood City. California, publishes a quarterly Enterprise Usage Study, Application Service Provider Report. According to its fourth-quarter 2000 report, based on a sample of 137 respondents from large corporates in the U.S., 65% companies currently access applications that are paid for on a rental or as-needed basis from an ASP or ASP hosting organization and of the 35% that either did not, or were not sure, all planned to do so within the next 12 months.

Two models are front-runners

London-based Robert Tickell, European ASP segment manager at IBM Corp., sees two successful ASP models emerging. In vertical, niche markets he gives the example of an online community for dental surgeons, using specific applications to gain data about new treatments and order drugs and equipment. "There is a lot of value in something so targeted" he says. "It's a valid business model and can be provided within a very simple ASP value chain."

He also thinks rolling out new and targeted applications is another strong route to gaining revenues. "Equally valid is [the high-end example of] a large corporate buying a sales force automation tool and rolling it out across multiple locations and languages via an ASP," he says.

Specific, targeted applications such as these may hold the key to ASP success or failure in a future, consolidated market. Indeed, some hosting and applications services specialists say there is a flaw with the model of a generic ASP, simply because of the overwhelming choice of applications to host.

"There are one hundred and fifty thousand independent software companies in the United Kingdom alone," points out Meri Braziel, managing director of PSINet UK Ltd., of Cambridge, England. "It's hard for anyone to know what to start with."

PSINet argues that in any case both service provider customers and corporate customers want be spoke and finely tuned software services from a network provider which can deliver connectivity guarantees.

Braziel says PSINet hosts less than 50 applications for other service providers, some of which support fewer than 20 corporate customers. But in all cases, she claims, PSINet had to carry out extensive integration and development work, either to make new applications work within standard systems such as Windows 2000, or because corporates had a mix of hardware across which applications had to work.

Another network service provider targeting the corporate market globally with ASP services is Equant NV, of Amsterdam, which is currently piloting a portfolio of services with a customer prior to full rollout next month. "We're delivering service to our first customer," says David Walker, product manager at Equant Network Services in Slough, England. "We've designed services for the corporate customer and have found specific interest in the services in the Asia Pacific region, partly because of the geographical dispersal of offices in the region."

Walker also thinks there could be an opportunity to deliver vertical applications, perhaps for more specialist players. "Maybe there's an opportunity in offering vertical applications, but our customers are large corporations so we're not tapping the vertical market."

Is integration the answer?

But according to some commentators the market will only really take off when ASPs, far from targeting specific niches, are able to provide a truly integrated, full-service offering. Until then, much of the model's potential is not being realized, they argue.

Seven Mountains Software AB, of Oslo, Norway, is a developer of infrastructure software that enables the integration of multiple applications from ASPs offering packaged suites of software. "[The ASP market] has a long way to go before it matures; it will probably take two years," says Patrick Coates, the company's U.K. managing director, "I'll be interested to see how many ASPs are around then because I'm not sure how many have real value to offer. All that's happening at the moment is people taking little bits here and there rather than offering a complete service."

Demonstrating "real value"

Users' perception that they are being offered real value is an important aspect. According to the research from Zona, U.S. corporate companies not currently using ASP offerings cited some very specific reasons for making that choice (see table). Among the reasons was the fact that corporates thought they had sufficient IT resources in-house and that they saw no apparent cost advantage.

First, ASPs need to demonstrate to end users that the ASP model presents an improvement, in terms of productivity, cost, or both, over their existing facilities.

According to David Mills, vice president commercial, FutureLink Europe Ltd., Newbury, England, the typical cost for office applications--including, among other things, maintenance and help desk facilities--is roughly [pound]160-[pound]200 per user, per month. That cost, he points out, has to be justified across the whole business and balanced against the costs of recruiting in-house expertise to maintain the applications. Taking these factors into consideration, applications can work out to be a huge cost for large users.

But the ASP market may not all be about large customer accounts. In the last few months, the focus in the U.S. and Europe has been on the small-to-medium-sized enterprise (SME) market, which many service providers think offers huge revenue opportunities in the way of delivery of desktop applications.

Aiming at ISVs

Cable & Wireless a-Services' Keeping says its parent company, in a joint venture with Houston-based Compaq Corp., is staking a $600m investment on this sector. Cable and Wireless a-Services offers bundled desktop packages and hardware on a per user, per month rental basis (CWI 19 June 2000, p.18) in partnership with Compaq and Microsoft Corp., of Redmond, Washington.

"We've set out in the early stages of development of the business to offer a full service offering for SMEs. Our sweet spot is organizations with between 50 and 500 users. The ideal verticals are in service industries," says Keeping. "We see office applications as a core platform, but it can't stop there. Ultimately, the right answer is an integrated suite of software that goes beyond office applications."

In line with this, some analysts think gaining volume sales is critical at this stage of the market's development. "We're in a period of consolidation," says Delaney at Ovum. "The market is very crowded and revenue has come more slowly than many might have hoped. In the next couple of years the best way to success is to target a large customer base. ASPs must not focus on vertical applications. They must go for applications used by a large number of customers.

Offering a full range of solutions may be the best way forward for many players. "ASPs that focus on one particular, or a limited set of applications, are making a mistake, because the fundamental benefit of ASP is that users don't have to have administrative and hardware systems in place," continues Delaney. "ASP is a means of making life simpler and allowing organizations to focus resources on their core business."

Keeping anticipates much of the Cable & Wireless investment will be recouped from diversifying its current service to cater for other ASPs and carriers. "Having invested in capacity and scale for our platform, another important market for us is these alternate channels to market," he says. "We have, in effect, built an infrastructure platform we can sell to other ASPs to build their own services. An example would be ISVs [Independent Software Vendors] who want to offer applications online using our platform, data centers and connectivity."

Some players claim to be seeing real growth already and think ISVs are driving the SME market. "There's definitely been very quick growth in the last quarter," says Andrew Cloney, chief operations executive at Pasporte Ltd., an ASP based in Bagshot, England. "I think the increase in customer demand has been lead by ISVs in the SME market. ISVs are beginning to see that ASPs can be profitable for them, although there was initially a lot of reticence."

Christian Fronteras, business unit manager for Europe. Middle East and Africa, JD Edwards & Co., of Denver, Colorado, thinks smaller corporations will embrace outsourced office applications, but warns that because they will become a commodity this may not result in significant revenues for service providers. "Smaller corporations, perhaps those that lack IT infrastructure and skills, will look to ASPs to deliver outsourced IT services," he says. "Office applications will become the commodity of the ASP business. In the long term they will be bundled into a solution as a given."

Creating long-term added value

Mills at FutureLink argues that standardized applications delivered to smaller businesses is not the way forward for ASPs. "I don't think the SME market is ready to take off," he says. "In the U.K. we had to throw out the analyst material because we weren't getting any SME business," he says. "I don't think there's an appetite in the market for delivery of standard applications down a piece of wire because I don't think they're relevant to people's businesses."

Because of this, adding value to the ASP proposition may be vital to some players' survival. Mills considers it to be critical that ASPs think about who they want for their customer. "To be a financially successful ASP you need to sell to financially successful companies. If they have a trading history they have legacy applications and data that needs integration," he says. "The ASP has more value to an organization with poor or no IT infrastructure."

Fronteras also emphasizes that ASPs need to focus on their value proposition. "Long-term it's a no brainer," he says. "ASPs need to focus on building unique value propositions that differentiate them from not just one another but also traditional companies. As they develop, ASPs must focus on creating added value."

The challenge now for ASPs as the market consolidates is to find the right point on that value chain on which to focus.

Delaney at Ovum says that the middle market is most attractive to many ASPs in the current climate. "There are two ends of the spectrum: there are costly, customized applications that can be sold to one customer at one end, or basic commodity applications that can offer economies of scale but don't allow ASPs to differentiate at the other. The sweet spot from the ASP point of view is somewhere in between, where they can sell applications that require enough customization to differentiate, but offer the opportunity to achieve economies of scale through re-using a customizable platform."

Coates, at Seven Mountains, sees only a short-term opportunity in the delivery of desktop applications. "Everyone wants office applications because they're using them already," he says. "It's a comparatively easy sale, but in the long term the big money is going to be in the corporate market. There are organizations with hundreds of applications. To go to the corporate market you have to offer more than office applications."

Nick Harper, technical architect at Webgenerics, a subsidiary of Business Systems Group plc, London, a provider of online applications for e-business, thinks tools that enable e-business trading delivered on an ASP basis will provide the added value businesses are looking for. "Typically, taking office applications online is not a major business benefit," he says. "The real revenue potential is tied to businesses and their Web sites. They want to use Web sites as part of their core function."

Steve Vanterpool, emerging markets channel director at UUNet Inc., goes further, saying the ASP model has more relation to traditional outsourcing than bundled office applications. "I don't think bundled office applications are the immediate opportunity," he says. "The ASP model is an evolution of the outsourcing model."

Perhaps because of this, some end user companies' strategies for ASP services run deeper than simply applications provision, and in many instances go right down to internally integrated infrastructure to provide those services to their own users now or in the future.

Why companies are hesitating

Zona Research's Enterprise Usage Study at the end of 2000 found that many organizations either already provide or are looking to provide in the near future an internally integrated ASP business model.

According to the study, currently 19% have implemented an internally integrated ASP model, 6% plan to do so in the next six months, 12% in six to 12 months and 9% in more than a year's time. However, that still left 54% of respondents saying their IT department had no plans to provide such infrastructure.

Among issues holding customers back from a full-blown strategy are concerns over service reliability and security. "Everyone's talking about service level agreements (SLAs), but are they the best way of managing services?" asks Coates. "The big question is will your network reliability be better [with an ASP] than with what you have got already? Once it hits a customer site the service provider loses control."

By the same token, even given the implementation of suitable security levels by service providers on their own networks, the problem of internal breaches remains. "Often the customer network is the concern," points out Coates. "A high proportion of security intrusions are from staff."

Mills at FutureLink thinks convincing customers to entrust their data to an ASP is a significant barrier to sales. "The most difficult sell is to convince customers it's not a concern if their data moves out of their building," he says. "If you enter negotiations with an ASP starting with the service level agreement, you are approaching the relationship in the wrong way.

"SLAs are there to protect against poor performance, but not really for compensation," Mills continued. "We write jointly negotiated SLAs that are two-way. We're not responsible for what goes on at the customers' premises."

Keeping, at C&W a-Services, thinks SLAs are a critical ingredient in offering cohesive application services. "More and more ASPs are putting in pretty serious SLAs," he claims. "The key aspect is reliability and availability of service. In a law firm, for example, Microsoft Word could be viewed as a mission-critical application."

Perhaps reflecting a greater trend towards more comprehensive SLAs, Zona's Enterprise Usage Study found that 92% of respondents outsourcing ASP services felt their current SLA met their needs. Of the 8% that felt their SLA was not adequate, greater guaranteed availability was cited by all respondents as the most important factor.

When it comes to providing guaranteed availability, network service providers claim they have the best position. "Telcos like us with our own infrastructure, data centers and managed services can provide an end-to-end service that is critical," says David Walker, product manager at Equant Network Services of Amsterdam. "You've got to guarantee a [certain] level of service. Over a high-quality private network you're going to be able to do that."

IBM's Robert Tickell advises ASPs to bring up the subject of security and SLAs as early as possible in the customer acquisition cycle. "Security has to be part of the up-front sales value proposition. There's no point waiting for objections about reliability and security to come through," he says. "It needs to be more than words."

But Vanterpool at UUNet is not convinced that SLAs are the right approach to reassure customers. "No-one wants to fail," he states. "I don't think SLAs should be longer than two pages. The most important thing is to establish with customers how you are going to do business: rules of engagement should be established first."

ASP specialists claim they have gone much of the way towards reassuring customers and that a healthy market will emerge. "Without a doubt, ASP has been over-hyped, but the model has shown business owners there's a way to do information technology without having to do it yourself," says Mills.

"It will succeed, there's no two ways about it," says Coates. "The question is how many players will be around in two years to get the benefit. The companies that will be particularly strong will be those with a strong consultative approach to the market," he claims.

Tickell thinks the corporate market holds the key. "Once the corporate market comes on board it will begin to snowball," he says. "There is definitely curiosity with this model because it makes so much sense in theory. If the industry delivers to key customers, it will turn from curiosity to appetite. If it goes wrong in early implementations it will put the market back six months."

Before the ASP market levels out it seems more models will be tested. "If you go beneath the layers of the onion most people have no idea what an ASP is," adds Tickell. "The industry is learning as well as the customers." Those that don't soon learn the lessons of targeting or scale may find the growing pains too much to bear.

                 Which best describes the reason(s) you do
                  not plan to use an ASP within the next
                                12 months?
           Have sufficient IT resources to run
                         applications in-house 217
            No cost advantage for ASP services 167
        Concern about security of ASP-provided
                                  applications 116
               Do not trust ASPs with our data 114
      Do not want to get locked into long-term
                                     contracts 107
          Not familiar enough with ASP concept 100
  No ASP has ever contacted us about our needs  97
Application performance via an ASP is too slow  72
       Not able to adequately test or evaluate
                     ASP services at this time  72
                         ASP model is unproven  51
 Quality of ASP service is not yet good enough  44
                                         Other  37
401 questioned (multiple responses allowed)
Source: Zona Research, Inc.

Coaxing out a market: integrators and "enablers"

As applications service providers (ASPs) scramble to find a customer base they are equipped to serve and that will generate revenues, systems integrators and ASP "enablers" have come further into the spotlight.

"Everyone believed ASP was about the delivery of rented applications, but as the model developed we have found there's a lot more to it than that," says UUNet's Steve Vanterpool. "There's a lot of integration required. We're seeing a coming together of layers [from diverse technical disciplines] to assemble a complete ASP solution."

IBM's Robert Tickell agrees: "The ASP value chain is complex, multi-dimensional and constantly changing, and I can see systems integration being fairly fundamental to running services."

Systems integrators also have the necessary skills to aggregate diverse applications and make them work together. "Systems integrators are starting to become aggregators of applications on the Internet," says Nick Harper at Webgenerics. They have a lot of competencies that can be used to build services. A lot of them--and ASPs themselves--are not software houses but are good at gluing things together."

Stuart Keeping at Cable and Wireless a-Services thinks systems integrators have two key roles in the ASP chain. "There's a central systems integration challenge in providing services to ASPs to help them build delivery capability," he says. "Our approach is to use an indirect distribution model, through value-added resellers with systems integration skills, to deliver our services with other services into businesses we serve."

Patrick Coates at Seven Mountains Software points out that systems integratcrs are already well positioned to benefit from the ASP industry. "Companies that succeed will offer some form of consultative solution. Systems integrators have big clients, and they will use ASP as the ultimate outsourcing model. These are the people who are going to do well out of it. All they're doing is acting as an intermediary."

But some believe systems integration is not the only outside help ASPs need. "You need breadth and depth experience here," says Tickell. "It does require someone who understands systems integration, systems management, help desk services and customer support."

Because of this, large network services companies, with a mix of these skills, could experience strong demand. "Application infrastructure providers such as UUNet or KPNQwest will see their roles increasing," says Christian Fronteras at JD Edwards & Co. "They're starting to build more services for ASPs, and it's because of this that most ASPs are choosing to outsource infrastructure capabilities. Bringing together multiple applications from multiple vendors is a complex act, more complex than most companies could do themselves. Systems integrators are now finding the sweet spot is specific integration competency."

Indeed the more players that are involved in the ASP solution, the harder it becomes to see where the revenues for "pure-play" ASPs will accrue. Tickell, at IBM, issues this cautionary note. "The longer the value chain and the more players involved the more concerns I have. Half the value proposition of the ASP model could be killed by everyone in the chain taking their profit. All costs in the value chain must be managed to ensure everyone gets a reasonable return and customers feel there is still a strong value proposition for them."

The distinction between European and U.S. ASPs

The United States came first to the applications service provider (ASP) market and is now in a period of frenzied realignment, according to industry observers. Players who initially overprovisioned on staff and equipment to serve the ASP market are looking to redefine their roles in the delivery process and scale their capacities to market demand. Europe, meanwhile, is hoping to learn from the mistakes of the U.S. pioneers and provide services more in line with that demand.

Robert Tickell, European ASP segment manager at IBM Corp., says there are clear distinctions between how the U.S. and European markets should be approached. "My reading of it is the U.S. market started off seeing the ASP market as a venture capital and outsourcing-driven model, moving away from current in-house capabilities," he says. "In the European ASP marketplace, because it developed later and because it learned a lot from U.S. mistakes, it's become very obvious that European players are categorizing themselves into sectors where they want to play. In general, the business that's being written in Europe is not a classic move towards outsourcing. It's a way for new applications to enter the market, particularly in areas where there are a shortage of skills."

Stuart Keeping, vice president, global marketing, Cable and Wireless a-Services, also thinks the U.S. market needs to be handled differently to European markets because of differences in size, customer habits and current installed base of web-enabled employees. "The U.S. is a more mature market," he says. "It's also a more challenging market in terms of building a brand profile, but the benefits and rewards are much higher. The main difference is scale, although I'm sure there's a view that the U.K. market is uncharted territory and therefore more fertile ground."

Steve Vanterpool, emerging markets channel director at UUNet Inc., points out that the European market can't be looked at as one homogeneous whole. "We've been able to learn from experience in the U.S.," he says. "But in Europe there are different requirements in terms of adoption of new technology, culture, language, currency and law. The market is more a regional than a European thing."

Others find broad similarities between the markets. "European ASPs have yet to get to the same level of maturity in terms of selling their own value proposition," says Christian Fronteras, business unit manager Europe, Middle East and Asia, JD Edwards & Co., Denver, Colorado. "They very much focus on selling their infrastructure rather than their offerings, but the basic ingredients of the two markets are exactly the same."

Analysts also think European ASPs can benefit from using the U.S. experience as an early warning system. "The biggest lesson to learn from the U.S. is to modify the ASP business plan with the market," says John Delaney, senior analyst at Ovum Ltd., London. "It's still going to grow, but it's taking off more sluggishly than expected."

And, says Fronteras, it will be some time before ASP models begin to mature: "If this was a marathon, we've a long way to run to see how these markets develop."

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