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Tech Industry

When to outsource your Web hosting

Are companies doomed to run a technology business on the side in order to meet their customers' needs?

For corporate executives in both high- and low-tech industries, it?s a familiar scenario: software upgrades that hit the market every few months; wired and wireless devices that seem to proliferate overnight; a lack of available and qualified network engineers, programmers and database administrators to handle online demands.

Is it necessary, these executives must sometimes wonder, to run a technology business on the side in order to market to, sell to and satisfy a company?s customers?

Clearly, the answer is no. The key is knowing when to turn to the fledgling industry of service providers that host, manage and serve up online e-business applications.

Outsourcing IT has many advantages, not the least of which is that it allows companies to focus on their product, their skills and their customers. As Gerry McCartney, chief information officer at Wharton, puts it, "You are trying to hold the core of your business as close as possible and get the operations (functions) as far away as possible." The idea is to maintain control over the services that "make you special."

In the beginning, a company may have hung out its online shingle with a single server, a T1 connection, a few Web pages and off-the-shelf software. In short order, that can change as bandwidth needs increase, server counts grow, the flexibility of the site?s software is put to the test and customers come to rely on the convenience of Web access. A company can be forced to support a large online application, with corresponding needs for a trained technology staff.

At some point, executives must look at where they can best use their tech staff to serve the company?s core mission while leaving the rest to vendors.

Indeed, in the months to come, companies may find that outsourcing is not just the best way to get the work done, but the only way. In April 2001, the Information Technology Association of America said although U.S. companies hope to add 900,000 IT workers this year to a work force of 10.4 million, nearly half that expectation will be unmet. The problem: too few skilled workers.

Indeed, in the months to come, companies may find that outsourcing is not just the best way to get the work done, but the only way. Additionally, corporate information technology departments "presume they are going to do these things for themselves, but it?s a new kind of skill for them," says David Rowe, director of strategic planning for Intel Online Services. Rowe?s unit is one among a host of companies offering various levels of online management services.

Outsourcing a company?s operation can take a variety of forms, depending on strategic and financial needs:

Collocation: The company rents space off-site for its own servers and maintains the data, content, software and hardware. The service provider networks those servers to the Web and offers some security for the machines. It?s a first step, and often less expensive than more expansive forms of outsourcing. This approach has been called "unmanaged hosting."

Managed Hosting: The company turns over responsibility for core online work to an outside vendor. Depending on the level of managed hosting, this can range from vendor-managed hardware alone to turning over an entire online operation--content, networking, data, software and hardware. Expenses can vary depending on the complexity of the operation.

Subsets include:

Shared hosting: The company shares server space with other clients. The company maintains its own data, content and software.

Dedicated hosting: Data, content and software are hosted on machines built and maintained specifically for the client?s needs. A company could also contract out responsibility for maintaining the supporting data-management software, e-business applications and the content itself.

Companies that have invested in attracting, retaining and serving customers are often loath to turn over any part of that task. In some cases, that instinct is correct; customer service may best remain an in-house job for some functions of the business.

Before making their decision, executives should ask themselves several questions. For example, what is their core business? At an Intel focus group, a national hotel chain discussed its needs. The company kept responsibility for taking and maintaining its reservation services. That first contact with a customer--and vital reservation data--was core to the company. Other functions were outsourced.

Opportunity costs are another consideration. The fewer network administrators and server operators McCartney hires at Wharton, the more he can spend on creative programmers and database administrators, the people who add value to an IT department.

The creative people are the ones who can spot trends and capitalize on them. In addition, managed hosting services can provide more flexibility. For example, adding server capacity to an internal operation requires a torturous capital budgeting process, McCartney says. A service provider can add capacity on the fly.

Reliability is another issue. Just before Christmas 1999, Toys "R" Us ran a promotion for customers who spent more than $100 on its online store. The resulting crush of traffic forced the company to turn away customers it couldn?t handle. Fourth-quarter earnings that year were down 27 percent. A study by The Yankee Group shows that providing 99.999 percent availability--the vaunted "five-nines" standard--can cost $472,000 a year in-house, but $380,000 when managed externally. Why? Service providers are focused on their core business, says Larry Buchsbaum, author of the report.

According to The Yankee Group, more than two-dozen vendors provide some form of outsourced Web hosting services. They run the gamut from large telecommunications companies to pure-play hosting and Web-management companies. In general, however, the level of customer satisfaction in the managed hosting industry is low. The industry, says Rowe, "does a poor job of setting the expectations of the client. That?s where we find the most dissatisfaction."

Both Rowe and McCartney agree that the best defense against risk is to spread it around. The hotel chain mentioned earlier used four separate companies for various parts of its hosting needs--and, at one point, replaced one of them for poor service. "It?s a dangerous strategy to outsource to a single vendor," McCartney says, adding that if possible, a company should take an equity position in any vendor on which it leans heavily.

In general, controlling costs means working with the vendor to help draw boundaries. For example, a company can insist on fewer servers, with load-balancing software, knowing it can add capacity quickly if necessary. The company can opt for fewer hours of live support, keeping labor costs lower, and settling for pager service after hours. Finally, instead of limited upgrades, clients can choose to limit themselves, agreeing, for example, to no more than five changes a month, with an accompanying service charge if extra services are needed.

McCartney cautions against eliminating IT people entirely. The creative people are the ones who can spot trends and capitalize on them--perhaps unearthing new business opportunities in the rush of technological innovation. "If you?re to understand the business implications of how things in IT change," he says, "it behooves you to keep some of your IT staff in house."

 
To read more articles like this one, visit Knowledge@Wharton.

All materials copyright © 2001 of the Wharton School of the University of Pennsylvania.