Commentary: ASP models face uncertainty

Nothing seems certain these days about the application service provider (ASP) market--especially given the skeptical financial environment.

4 min read

Nothing seems certain these days about the application service provider (ASP) market--especially given the skeptical financial environment.

Not only are ASP business models in constant flux, but corporate demand for weakly integrated, "vanilla" application function as a "service" is also unknown. Given this uncertainty, we believe J.D. Edwards' quiet decision last fall to withdraw from the ASP arena made good business sense.

To deliver an ASP solution to users, a number of technologies must be engaged--ranging from data center hosting to application delivery. J.D. Edwards' announcement indicated a management realization that it does not need (and should not enter into) the business of providing data center operations. It can still provide and deliver its application by allowing partners to offer the hosting services. Indeed, some ASP offerings (such as Corio and Oracle) have never provided hosting internally, but always depended on partners.

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The application delivery challenges may be even more daunting. The original ASP vision had corporations purchasing relatively common sets of application services. However, few large businesses are without legacy applications that must be maintained. To date, the ASP market has yet to articulate a simple approach for integrating hosted application services with installed legacy applications. Integration and customization usually are left to service providers: systems integrators and outsourcers.

ASP and you shall receive?
Indeed, our research suggests that ASP prices jump 200 percent to 300 percent when even modest levels of customization (7 percent to 10 percent of function) are required. To be successful as an ASP, a company has to do much more than just license its software. Most ASP companies that we have talked with charge extra for integrating and customizing their software and see those services as a profit center and a differentiator in the market. Software companies that attempt to start their own ASPs soon discover that they need to develop much more depth of knowledge of specific markets and integration techniques than they are prepared to do.

Software and service vendors still view the ASP approach as a key to reaching the small- and medium-sized enterprise (SME) market. Recent primary research into the target market segments for ASP services (SMEs, typically with annual revenues up to $2 billion) shows that almost 70 percent are open to the idea of ASP service delivery. This suggests clear market potential in a customer segment that has avoided ERP (enterprise resource planning) applications due to licensing, implementation and maintenance costs.

New companies that are experiencing rapid growth and have insufficient infrastructure and immature skills are the most likely users of ASP offerings. For these fast-growing firms, time to market with sufficient, scalable systems is critical to seize market share. They don't have time to wait for the development of a homegrown infrastructure.

We believe most software vendors will partner with service providers--independent ASPs and especially large traditional outsourcers that have ASP arms--to reach this market. Over the next couple of years, large outsourcers will begin to leverage their infrastructures and technical expertise to provide services that leverage ASP service delivery (such as online trading environments and marketplaces). Software vendors will have the opportunity to significantly increase sales into these market segments through these partners, especially if they are willing to consider alternatives to traditional license-sale business models in support of these efforts.

Tempered ASP-irations
Users should be very skeptical of the staying power of pure ASPs. Even Corio and US Internetworking, the market leaders among pure ASP vendors, are still not profitable, and many people in the financial community believe they will never make a profit. Only the large outsourcers, which already have the necessary data center infrastructure and experience in integrating and customizing applications, are likely to have the staying power to survive in the ASP market, and we believe the ASP segment will probably be a small part of their total business.

Enterprises that do use pure ASP vendors (not the large outsourcers) to host applications must be prepared to move to new service providers if their present vendor fails financially. Therefore, while companies might use an ASP for small applications or to support peripheral operations, they should not commit to an ASP version of highly customized, central systems such as ERP or CRM (customer relationship management), which are central to the business and would be very difficult to move.

However, users must distinguish between the ASP arena and the overall outsourcing market. We believe that outsourcing will grow during the next decade and that users have no reason to be overly concerned about the long-term viability of the major traditional outsourcers. Although we believe most ASP start-ups will disappear, the mainstream outsourcing market will grow 20 percent to 25 percent per year through 2005-2006 from its $100 billion base in 2000.

Users will outsource to achieve higher quality, faster time to market, lower risks and expense management (lease versus buy), which is counter-cyclical in a recession. Therefore, IT groups should not let the ASP turmoil influence their overall outsourcing decisions, but should evaluate outsourcing as a tool to augment and supplement internal capabilities. By 2006, we believe, application service provisioning will be considered a pricing model for purchasing services rather than a discrete market.

Meta Group analysts Dale Kutnick, Dean Davison, Peter Burris, Daniel Sholler, Mike San Fratello, Christopher Hanna, Robert Johnson, Wilson Rothschild and William Zachmann contributed to this article.

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