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The battle over renting software

Business software makers and emerging applications service providers are squaring off to provide hosted services, a trend some say could revolutionize the software business.

A battle is brewing that could drastically reshape the normally staid world of business software.

Traditional business software makers and emerging applications service providers (ASPs) are squaring off in the market to provide hosted services, a trend some pundits predict could revolutionize the software business. ASPs host everything from software that tracks back-office financials to procurement software that companies use to buy and sell with partners online.

Whether dot-coms or the Fortune 500 will latch on to the new software rental model first is anyone's guess. Just in case the market takes off, big software makers including Oracle, SAP and PeopleSoft--which is expected to launch its own ASP next month--are building businesses quickly.

Analysts say software makers are jumping into the ASP market for the same reason that telecommunications giants such as AT&T are investing in building hosting centers that will house rented business applications: to nab new profits by providing customers with new Net-based services as competition from rivals stiffens and sales of traditional software products dip.

Chris Rowen, a financial analyst at Robinson Humphrey, said he expects ASPs to corner more than 50 percent of software sales within three years. While the ASP market is still in its infancy, it is expected to grow to $2 billion by 2003, according to market research firm International Data Corp. Forrester Research, which defines the ASP market more broadly, estimates the market represents about 2 percent of software sales today and expects it to grow to $11 billion by 2003.

Under the ASP model, customers pay to have their software hosted, shelling out a monthly fee to access the software through a Web browser via a leased telecommunications line. In most cases, the company pays for the software license up front and strikes a three-year maintenance deal so they don't have to deal with upgrades or technical problems. Every major technology provider--from Intel and Microsoft to MCI, Nortel and SAP--is touting an ASP strategy.

While software makers say they are targeting their ASP services to midsize firms with revenue between $100 million and $1 billion, David Roddy, a professor of Internet economics at Columbia University, believes the largest companies with lots of software headaches are more likely to be their first customers.

"The whole ASP movement is saying: I don't want that crap in my office, put it out in cyberspace," said Roddy, a former Deloitte executive who has studied the ASP market. "It will be the Global 2000 first."

Nonetheless, enterprise resource planning (ERP) software maker J.D. Edwards is betting on the dot-coms and newly launched divisions within established companies with its ASP offering, which it launched last month.

Mark Forgea, senior manager of worldwide ASP sales, said the start-up strategy is intended to prevent cannibalization of J.D. Edwards' software sales to larger companies. Forgea said the company has rebuilt its software so it can be easily integrated with Ariba's procurement software, Numetrix's supply chain software and Siebel's sales and marketing software, which the company will host for its customers.

"Dot-coms are the low-hanging fruit," Forgea said.

A large part of the ASP market is expected to be dominated by the so-called pure play ASP that will host for customers on many different software maker's products and operating systems.

"Pure plays like Corio and USinternetworking and Applicast in the SAP space do the distinct two things Oracle will never do for you: support non-Oracle software or support a non-Oracle environment," said Josh Greenbaum, analyst at Enterprise Applications Consulting in Berkeley, Calif.

Oracle's chief Larry Ellison--among others--has recently argued, however, that the future of software is in direct Net rentals and has established a separate company, Oracle Business OnLine, to nab new services business. Oracle and its rivals are also scrambling to reconstruct their client-server software so it is easier to integrate with Web-based applications and simpler to outsource. SAP's new Java-based version of its core software, R/3, is due next year.

For now, Oracle's Business OnLine is run like a fledgling start-up with a big shot parent. After a recent management shake-up, the unit has regrouped, moving from a warehouse to new office space in Belmont, Calif.

Business OnLine has about 100 employees worldwide who sell 36-month services contracts to Oracle customers, partly through leads from Oracle's 10,000-person sales force. The unit has 45 customers, most of them accessing Oracle's financial applications, according to Business OnLine president Tim Chou. Chou said BOL will likely grow up to 25 times its current size over the next year and is expected to spin off from Oracle.

"This is the way software is going to be done," Chou said.

Rather than launch a separate ASP practice, Oracle rival SAP has partnered with EDS, Qwest, Interpath Communications, IBM and Siemens to develop an application hosting strategy. SAP says 5,000 users are hosting the company's mySAP.com applications via its partners.

PeopleSoft, meanwhile, has partnered tightly with ASP Corio, which is owned partly by PeopleSoft and is expected to soon announce its own ASP practice. Corio's CEO George Kadifa says the perception that there will be great competition between ASPs and software makers such as PeopleSoft is overblown. Kadifa contends PeopleSoft and others will work with ASPs to "maximize their business models" and reach smaller markets that their sales forces are currently not targeting. Typically, an ASP pays a commission to software makers when it brokers a software leasing deal with a customer and makes its real profit off the services and support contract.

Kadifa balked at the notion that companies such as Oracle will garner half their revenues from services such as Business OnLine over the next five years, as the company's executives have stated in past interviews. He said he doubts revenue models will change much: Software makers will still rest the bulk of their revenues on selling licenses, while ASPs will sell services.

"There's a lot of uncertainty, a lot of bold statements (from software companies)," he said. "Frankly, you need to go beyond that."

Enterprise Applications Consulting's Greenbaum said that for many small to midsize companies, ASPs--whether a software maker or a pure play ASP--will offer a price tag that's much more enticing than a license purchase.

"There's a lot of money at stake for the midmarket," he said. "If (your company) has a $250 million revenue base and is wasting $5 million on e-business and ERP installation, it's is a huge disaster you want to avoid."