Software makers see gold in rentals

Advocates say applications outsourcing and hosting--the option to rent access to software online instead of buying it--is expected to explode among mid-sized firms because they can save money and avoid managing complex systems themselves.

Companies which sell software in this market, also known as Enterprise Resource Planning, or ERP, are beginning to ponder the impact that applications outsourcing could have on a $16.6 billion industry that's in flux as it searches for new sources of revenue.

The outsourcing trend could be just what ERP companies have long been searching for, a way to reach the smaller companies that cannot afford to buy their software, which can cost millions of dollars.

That's music to the ears of companies like SAP, PeopleSoft, Baan, and Oracle, which have seen sales dwindle in this area as the big-business market has become saturated. These companies stand to collect a monthly fee from an outsourcing deal rather than a lump sum charged in a sale.

Just one thing is needed to make this dream scenario come true: customers. So far, few companies have been willing to gamble on application outsourcing, and analysts are questioning how far it will go toward improving software makers' profits.

All ERP companies have reported lower earnings in recent quarters and are grappling with new Web-based strategies and, at the high end of the market, the switch to customer relationship management software used for front-office operations. This week, SAP co-chief executive Hasso Plattner blamed his company's financial troubles on the Year 2000 problem and a delay in introducing Web-based applications.

"[Outsourcing] is a viable channel," said Hurwitz Group analyst Steve Bonadio. "It's still very young, and there's an incredible amount of interest. But not a lot of companies are doing it today. Very little money is being made in the market, but the potential is huge."

Research firm IDC expects spending on services offered by application service providers, which offer the hosted applications sold or licensed to them by ERP software makers, to reach $150.4 million worldwide this year. IDC predicts that the ASP market--which includes hosting of e-commerce, email, and other business applications--will grow to $2 billion by 2003, representing a 91 percent annual growth rate.

Not everyone is sold on the concept. Jim Shepherd, analyst at AMR Research argues that the numbers analysts are churning out are "completely and utterly absurd." He questions the appeal of "giving away the family jewels" to a company that hosts your critical financial and business data from a remote location.

Nonetheless, ERP software makers are partnering with ASPs "just in case" the market takes off, Shepherd said. "If this thing gets hot they want to be in a position where they won't miss a beat," he said. "Privately, application developers are just as skeptical as I am about whether this is going anywhere. They aren't committing a dime. Their total development is writing a press release."

It's true that in some arrangements between the ERP company and its partner, the heat will be on the ASP to sell the service, not the software maker. Others are training their sales forces to pass leads to the ASP or sell the service directly. In any case, channel conflicts could arise.

"What I expect to see over the next year or so is a bunch of companies formed around applications outsourcing will tank because the business isn't materializing and some of the partnerships [between software makers and ASPs] will fall apart," Shepherd said.

SAP, PeopleSoft, Baan, and J.D. Edwards are still cutting deals with partners, educating their sales forces and clients while preparing to market their new services. Together, they probably have fewer than several dozen U.S.-based customers outsourcing their applications.

ERP market leader SAP has partnered with systems integrator EDS; PeopleSoft has cuts deals with Corio and Usinternetworking; and Baan is now working with outsourcing partner Bull.

By the end of next month, J.D. Edwards, which has been testing its ASP business model for two years, plans to announce partnerships with a large telecommunications firm that will host its applications and an ASP to run its new business. The company is already working with IBM Global Services and some smaller firms and has signed several customer deals for outsourcing its core OneWorld product line.

Deloitte & Touche and Arthur Andersen have also signed to host J.D. Edwards's applications, the company said. Under J.D. Edwards' model, the outsourcer sells the services and pays a cut to them to use the software.

Taking a different route is Oracle, which is hosting its own applications with Oracle Online. The company this week announced that it has signed its first dozen customers for its Business OnLine hosting service. The service provides applications to handle most business needs, including accounting, manufacturing, and procurement. Customers pay a monthly fee to use applications through the Web or a leased connection.

Another big question is whether ERP companies will be hurt by lost software sales lost as more companies follow the outsourcing path.

Mike Connolly, J.D. Edwards' business development manager for enterprise application outsourcing, argued that deals won't cannibalize the company's software sales but instead open a new distribution channel.

For Connolly, the market sweet spot is clear: $25 million to $250 million companies to whom ERP systems are not considered "mission critical," meaning that they depend on the software for simple accounting needs, rather than to give them an edge over a competitor.

On average, outsourcing will cost between $500 to $1,000 per user, he said, with the one-time cost to integrate the applications folded into the monthly fee throughout a typical three-year contract. Connolly argued that the cost of outsourcing cannot be easily compared to buying the software, as an ASP contract includes management, support, and help desk services.

The company plans to target its outsourced services by industry, such as oil and gas, health care, and real estate.