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Microsoft--the host with the most?

Microsoft is relying on hosting partners to expand sales to small businesses of server products, such as its Exchange e-mail software.

By acting as a middleman, Microsoft is building a new audience for key server applications and gaining experience that could prove valuable in the nascent market for utility computing.


What's new:
Microsoft is increasingly tailoring its server products, such as Exchange 2003, to be attractive to hosting companies in the small business market.

Bottom line:
Although the software giant could enter the hosting business itself, so far it has shown little inclincation to do so. For Microsoft, the risks, such as alienating partners and doing the hand-holding required, outweigh the benefits.

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A growing number of Microsoft server applications--most notably its Exchange e-mail server--are being resold as hosted services by third-party vendors that target small-business users. Analysts and partners give credit to Microsoft for making its products more host-friendly and say the software giant has shown no interest in providing such services on its own.

"It's pretty clear from Microsoft's perspective that they looked at the potential (for being a hosting provider), they looked at the economics, and they decided not to do it in the short term," said Rob Helm, an analyst at research firm Directions on Microsoft. "They're a software company, and they're happy that way."

"Software as a service" was the tech industry's mantra a few years ago, when Microsoft and others made large bets that applications would increasingly be delivered as Web-based services. That vision didn't play out then, but it is starting to take hold now in some segments., for example, has successfully challenged giants such as Siebel Systems by offering customer relationship management (CRM) software as a hosted service, prompting competitors to offer similar subscription services.

In addition, IBM's Lotus division has offered host-ready versions of its Workplace messaging and collaboration tools for some time. But the focus there is on enterprises looking to simplify administration and to buy into Big Blue's on-demand computing initiative.

By contrast, Microsoft's hosting partnerships have squarely focused on small businesses, where competition largely consists of tiny vendors offering low-end services and a few exploratory efforts by companies such as small-business software specialist Intuit. That company recently introduced QuickBase, a hosted collaboration service tied to its QuickBooks accounting software.

But there appears to be plenty of opportunity for those who think small, especially in messaging. The Radicati Group expects the market for hosted and managed business e-mail providers to grow from $2.3 billion last year to $3.1 billion in 2007, driven by small businesses looking to upgrade their e-mail service without having to buy and maintain their own servers.

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"They've outgrown POP e-mail. They want something more sophisticated, but they don't want to go through all the headaches of managing a server," said Sara Radicati, chief executive of the research firm. "Hosting becomes a very attractive alternative, from a price point--and because it relieves them of the support burden."

Ignacio Davila, the product manager for Microsoft's platform hosting group, said the hosted Exchange business has grown 80 percent in customer numbers in the past year. "Basically, it's small business," he said. "They want to have more control, and just having a Hotmail address is not seen as very professional."

Small businesses also want their own domain and collaboration services that they wouldn't be able to offer on their own, and they want them without having to pay big up-front costs, he said.

Davila added that the challenge for small businesses is: "Am I going to buy a $3,000 server and spend 10 percent of my time to make sure it's running to get this new functionality, or is it going to cost less for me to let somebody else run it?"

Piggyback hosts
Microsoft is also counting on hosting services to help push the adoption of its new server-based products, including SharePoint collaboration software and Windows Rights Management Services, its new server product for restricting access to corporate documents.

CEO Alex Hawkinson of Apptix, which sells tools to hosting providers, said SharePoint especially expands the appeal of hosted software beyond small businesses to larger companies wary of biting off more than they can chew. "It's a new concept. The internal IT department maybe just doesn't have the expertise (in collaboration services)," he said. "So going the hosted route just lets you do it."

Hawkinson and others credit Microsoft with grasping the benefits of hosting without trying to grab the market for itself. Microsoft has always viewed itself as a software company rather than a distribution company, he said, and its third-party efforts are a natural evolution from traditional software resellers to a model that works well over a network.

With Exchange, in particular, Microsoft has demonstrated its awareness of how hosting partners can expand business, Hawkinson said. The e-mail server is used by many large companies, but, like rival products, has not made similar inroads with small and midsize operations. "This is all getting them new customers without having to do something that's massively outside their core competency," he said.

Directions on Microsoft's Helm agreed, saying Microsoft makes decent money from selling software to hosting providers and wouldn't make enough extra from doing the hosting itself to justify the risk.

"There's not enough money there, and there's a significant downside," he said. A recent domain service failure raised the question, "If I was running a mission-critical application, could I rely on Microsoft to do it on the Internet?" he said. "A failure in the hosted space could cause people to draw bad conclusions about the software as well."

Radicati pointed out that the costs of getting into the hosting business would outweigh the benefits for Microsoft. "Microsoft has always done very well from third parties reselling its products," she said. "To them, this is just another reseller channel. They get the licensing fees...and they're not saddled with management costs."

Working with hosting partners also gives Microsoft a stake in the emerging market for utility computing, the fuzzy but compelling concept of letting somebody else do all the dirty work. "Whatever you call it, it's just delivering applications as a service over the Net," said Apptix's Hawkinson.

Partners say Microsoft's commitment to working with hosting providers is reflected in the design of recent server products. "I've been dealing with Microsoft for the last five or six years, and each year, their products have gotten more favorable to the hosting market," Hawkinson said. "They're really dedicated to making this a viable model."

Retooling Exchange
Exchange 2003, the latest version of the e-mail server, has won particular kudos for features such as improved caching tools to more efficiently store messages and broader support for remote connections, eliminating the need to use virtual private networks (VPNs). While those enhancements benefit enterprise IT managers, they're particularly valuable to hosting providers.

"Microsoft has finally addressed the hostability issue with the technology behind Exchange 2003," said Cheryl Yetz, the director of product development for hosting provider NaviSite. "Exchange 2000 just didn't work very well with a hosted model. But they really worked with us and other partners to improve the product."

Microsoft's Davila said the company had streamlined VPN and consolidated the number of servers needed, making Exchange 2003 more attractive to be hosted.

He added that in making changes to its server products, one of the considerations is making them work better in a hosted environment. "We're starting to have an architecture on how to use it in hosted model," he said.

Helm said Microsoft has recently backed off on a number of large-scale hosting plans, such as reselling Passport authentication services to other online companies or using its bCentral small business sites as a launching pad for selling services.

The software maker also had to back off plans for .Net My Services, an ambitious scheme to run a central repository of consumer data that could be resold to retailers, when security concerns and overall market confusion sapped partner support.

Microsoft's hosting strategy now seems to focus on markets in which a hosted service may spur sales of another product. Examples include Xbox Live, the online service Microsoft is counting on to establish its video game console, and Live Meeting, a Web conferencing service with extensive ties to the company's Office productivity software.

"Probably the key area where Microsoft still may do things are cases where hosting a service helps sell software," Helm said.

Davila said Microsoft will continue to tread lightly in services. "Selling software is the fundamental part of our business," he said. "Microsoft also runs other services, obviously, but we have to be realistic in: What does it take to scale those services, and where is the best investment of our resources?"