Making Sense of the ASP Market

Try and name a player in the telecom industry who doesn’t think they will benefit from the Greenfield opportunities abound in the ASP marketplace. While its true, the dollar signs are everywhere; the fact is the industry is sinking money into the ASP model without a proven track record. As ASPs hash out their business strategies, both business and technical challenges await. Those who can effectively rise above the hype and make business sense out of this model will win out in the end.

If the ASP model is successful, it could be a tremendous benefit for small- to medium- sized businesses, which are often locked out of the market because of high software costs. Renting or leasing software frees up capital, and the ASP solution eliminates the need for an in-house IT staff, which is particularly beneficial given the dearth of skilled professionals to build, manage and maintain software. The scalability factor alone is an attractive incentive to potential ASP customers.

According to the research firm IDC, North American managers and business managers with whom the company spoke had a low level of familiarity with the term “ASP”—5 percent of IT managers and 8 percent of business managers said they understood the term.

“That’s a very low number when you consider the amount of hype that’s out there,” says IDC Research Analyst Amy Mizoras. “It really puts things into perspective.”

Pipe Dreams or Performance

Why now? Portal’s Senior Manager for Market Development Paul Hoff cites use of the Internet as a prime technology driver pressing the ASP model forward. Web browsers providing a standard platform as an interface into applications have paved the way.

Hasan Rizvi, vice president of engineering at Corio, adds that network ubiquity and performance are also driving acceptance of the ASP model. In the past, he says, the high price of networks was an inhibitor to this type of applications hosting.

Although some say that bandwidth is not a problem--it grows as the size of applications grow--networks must be able to support applications in a fast and reliable manner.

Customers are concerned about speed and quality of service, but these factors mean nothing if application delivery is crippled because of network failure.

“Let’s say I’m totally dependent on that Internet connection,” explains Hoff. “In some way, you need to take those applications offline and have them keep functioning if a disaster does happen.” One way around this, he suggests, is allowing applications to continue to function in an offline environment, with resynchronization as soon as the network is running again.

“We’ve done it for our [billing] software, but that’s not the underlying application that people care about. They don’t care that they still get the bill if that the line is down. They care that they can use the application,” Hoff says.

In terms of network management issues, packet application programming interfaces (APIs) can provide monitoring and management information about the network connection, explains Derivion’s Dushyant Sharma, president, chief technology officer, and company co-founder. Packet APIs allow the network operators or carriers to manage the network, solve connection problems effectively and re-direct traffic if a problem arises on one of the network routes.

ASPs Are No Different…

Integration within the ASP model is no less of a challenge. “Having business processes operate in an integrated fashion is not easy, because these applications are all architected differently and they operate differently,” Rizvi says.

An ASP can purchase billing software to track and bill its users, and Rizvi notes that, as an ASP, Corio may offer a billing application that fits into another application being used by a customer. This could require dumping billing or financial data into accounts tables within that other application.

Key to integration: is ensuring that when an ASP hosts an application that must interact with other applications, whether hosted or not, that these programs can work together. System changes or upgrades must be done without affecting every other application.

Many companies will publish standard APIs, allowing the customer to write against these to access data from the applications or put data into their applications. When a change is made on the ASP side, customers need not redo work. Standards such as HTTP and XML should enable ASPs to integrate their applications into existing business systems. Some experts say, however, that XML still must be proven in a high-performance environment.

Promise versus Delivery

One of the greatest challenges facing both applications providers and their customers is establishing clear service level agreements (SLAs) that protect the integrity of the application and the players along the ASP supply chain.

“There have to be some really clear definitions of accountability,” says Forrester Analyst Stacie S. McCullough. This market is still new and ASPs are still trying to figure out what kinds of services they need to provide and how to price them. These service agreements will have to be carefully architected so that, while ASPs are accountable to their customers, they do not take the hit for faults in the elements of the chain their partners supply.

Using the Internet to deliver an application is not always a sure method of transport. It is difficult to track SLAs for applications delivered over the Internet because there is an inherent lack of control of the public infrastructure. Currently, no viable solution exists, according to Hoff, and businesses are limited to non-critical business functions. Redundant links can increase the reliability of the transport, and back-up sites can provide further redundancy. Some experts say, however, that the network needs to become self-healing where SLAs are a concern, fixing problems as they are detected. Large ASPs and their customers typically have private networks in place, but SLAs are still needed to measure the end-to-end performance of applications, Hoff says. SLA violations also need to be automatically relayed to the billing system so that a credit would appear on the bill.

Risk versus Return

Although the type of outsourcing offered by the ASP model may be an excellent opportunity for the customer, the cost of doing business has to be pushed out somewhere, and ASPs are bearing the brunt.

“ASPs right now are actually taking on a lot of financial risk,” Mizoras says. In most cases, ASPs are giving their customers an annuity model to pay for the license, the software, or the service, but software and hardware vendors in the supply chain require the ASP to pay upfront for licenses or servers.

“It’s definitely a low-margin pie,” Mizoras says, adding that ASPs will likely try to make up for this low margin by selling additional services and growing their customer bases.

For customers, the ASP model may be attractive because less is spent upfront; however, the misconception is that the model is cheaper in the long run. Mizoras likens the process to leasing a car. When leasing a car, a customer does not have to deal with maintenance, but he still must make payments, and in the end, he does not own the car. ASP customers will not own the software, but neither will they have to worry about obsolete software or upgrade processes.

Pricing: Complexity or Flexibility

Currently, most ASPs are billing on a per seat, per month basis, but Hoff believes this will soon change. Competition will force ASPs to differentiate themselves, and pricing is likely to be this differentiator.

“Initially, we’re seeing flat-rate pricing,” Hoff says. “ I think we’re going to start to see per transaction pricing.” Other possibilities include subscription-type billing or rent-to-own billing.

In a typical instance, an ISP customer would initially register with a billing application through an ASP. This ASP would send this information to the ISP. In the future, the customer would be able to log on through the ISP, but all the usage information would be transmitted back to the ASP for processing.

Corio bills its ASP customers on a monthly fee based on level of usage, delineating several different levels. Some customers receive very limited transaction-based billing based on units such as page views or orders processed. “There is definitely a lot of room for standardization around how these services will be billed,” Rizvi says. Pricing should be based, he says, on how much data is being driven through the system versus a flat fee. Most of the transaction-based pricing information is captured on one system at the ASP, says Dataquest’s Dennis Wayson, vice president and chief analyst, consulting and systems integration practice. Wayson believes that the challenges revolve around pricing models.

Sales Channel Conflict

What about software vendors that are double-timing as ASPs? Where does that leave their pure ASP partners? When a company’s sales force comes into an ASP deal, do they take the deal or do they give it to a partner?

“In most cases,” Mizoras says, “if they’re trying to grow their own ASP business, they’ll keep the deal for themselves.”

Mizoras notes that some software vendors have been successful in selecting ASP partners by vertical industry or global location. Companies such as JD Edwards, she says, will turn to ASPs to provide applications in other industries or other regions in which another company might have a stronger presence or a better understanding of the market. “The extent to which companies can segment out their channel, make a piece for themselves and leave enough for their partners to be happy will be interesting to see,” Mizoras comments.

One software developer partnering with ASPs and creating its own ASP arm is PeopleSoft. In the past, PeopleSoft has brought many customers to its ASP partners, but according to one analyst, the company stated that six months after the March release of its ASP service, sales leads to partners would be directed to its internal ASP organization and not its ASP partners.

“That’s cutting off an important channel for the ASP partners,” Mizoras explains, because most customers are still buying applications based on brand and not on ASP name.

PeopleSoft denies they would cut sales leads completely from ASP partners. “It’s going to be a case-by-case thing,” says PeopleSoft spokesperson Joe Schmidt. “Where it makes sense, we’ll pass on leads, where it doesn’t, we’ll run with it with our own program.”

As an ASP that started out with PeopleSoft as its enterprise resource planning (ERP) backbone, Corio could be dramatically affected by the business strategies of PeopleSoft’s ASP arm. Yet Rizvi believes it is important for software companies to have a hand in the ASP model.

“These applications are not really architected or optimized for hosting right now,” Rizvi says. “The best way [software vendors] can learn about the problems in the applications is by doing it themselves . . . . It’s in our best interest that our partners have first-hand experience in how to develop and how to optimize applications for hostability.”

Still, conflicts could arise. “These software companies are going to have to give way to some of the channel conflict they are creating today,” McCullough says. “It’s not happening today because they still have 95 percent of their sales still coming through other channels. The ASP thing is just a gnat, but as that shift starts to change, we will see them have to go back and have to rethink these strategies. I think you will see a lot of the companies today that have their own competing ASP service starting to fold that down.” She suggests software vendors could handle this phenomenon by providing niche applications through ASP arms while allowing other ASP partners to bundle their software into multiple packages.

Up and Down the Value Chain

The ASP value chain encompasses countless layers of complexity. Delivering an application to a customer includes relationships with those who deal with transport access, network operations, data center operations, applications management and maintenance, systems integration and business integration.

A March study conducted by Booz•Allen & Hamilton for Lucent Technologies Incorporated revealed that for every dollar an ASP spends, only 7 cents is for licensing the software applications. Providers spend 24 cents of every dollar on equipment and software, bandwidth and data center staff. About another quarter of every dollar—26 cents—is spent on implementation and configuration, while customer service, sales and training efforts account for 43 percent of each dollar. From a billing perspective, this creates layers in which money must be sent back and forth.

In addition, some people suggest aggregators will arise to provide a single log on, compile an applications suite solution or provide a single bill. Whether companies who simply act as aggregators will actually add value or merely serve as middlemen is yet to be determined.

“You’ve got to figure out how much the aggregator owes the financial software provider and how much they need to pay their channel to distribute it to all the end users. The money flows become very complex in this environment” Hoff maintains. Derivion’s Chief Marketing Officer Read Ziegler points to a technical layer of complexity. Often, if a company has several billing systems in place to account for different applications, the billing cycles may not be in sync. It is difficult to pull all those cycles together into one bill, especially when trying to do this for a large number of customers.

What sells?

According to many ASPs providing services to telecommunications companies, the telecommunications market is a hot playing field. EBPP companies and OSS providers say the ASP model fits nicely with the transaction-based processes that telecommunications companies deliver.

The ASP model does not allow for heavy customization, because highly customized products for multiple customers make frequent upgrades impossible. However, companies want products that can meet their requirements, and watered-down software will not do. Thus, domain expertise will be critical.

McCullough says the ASP model will likely bring about a new class of Internet applications with a tremendous amount of configurability in terms of table structures and process options to circumvent customization.

Although most ASP business is being conducted in the business-to-business realm, analysts believe it will likely filter down into the business-to-consumer marketplace, according to CommTech’s vice president for Strategic Business Development Frank Lauria.

There are multiple technological barriers to accessing software in the home, but once DSL and broadband make it to homes, Mizoras believes the business-to-consumer side will start to take off.

Then, ASPs will need to offer more horizontal applications that fit the needs of a wide variety of customers. Employees who work out of their homes may be a particularly important consumer group.

Building Trust

The March Booz•Allen study cited security as one of the top three priorities for businesses subscribing to the ASP model. Customers must have faith in the model and trust its security.

Ziegler explains a typical reaction to billing: “ [Customers] look at the bill and they say, ‘Wow, the bill looks neat online and that’s all great, but how secure is it? This is money that is coming back into my company and if it’s compromised…that not only tarnishes my image severely, but it also is actual revenue to my company that is not coming in and it cripples my business.’”

Derivion uses password protection, SSL encryption and digital certificates; also, a senior administrator can set privilege levels for those who access the billing information. The ASP model does present areas vulnerable to security breaches. Companies must ensure that access to information being passed over networks is secure and must protect data stored in data centers as well as billing information.

While some companies are sitting back and waiting to see how the ASP model pans out, many are jumping in with vigor. Certainly, ASPs must address issues such as network performance, service level agreements and pricing if this model is going to work.

Playing the Numbers Game

Projected revenues for the ASP marketplace vary widely, but businesses are clinging to them to make the case for being an ASP. Figures from three research firms are dissected below to show how each firm defines an ASP and how they arrived at their predictions.

IDC estimates that ASP spending will grow to $7.8 billion by 2004. In their Worldwide ASP Market Size and Forecast 1999-2004, IDC defines an ASP as a company that provides “a contractual service offering to deploy, host, manage and provide access to an application from a facility other than the customer’s site.”

Analyst Amy Mizoras notes, “Some people will include Web hosting or application outsourcing in the category, whereas we consider ASP to be a subset of that.”

To arrive at their numbers, IDC spoke to vendors and took information from regional analysts to forecast global trends. The firm also used end-user surveys with high-level managers to determine their familiarity with the business process.

Forrester Research projects an ASP market of $11.3 billion by 2003. Forrester spoke to 28 “large” to “very large” businesses and 22 “medium-sized” businesses about applications hosting to arrive at its numbers. The firm’s report outlines the market for packaged business applications hosting, which it defines as “those applications offered as a service that contain business context and content.”

Analyst Stacie S. McCullough clarifies, “This is packaged applications only. The $11.3 billion includes licenses that are deferred over time.” McCullough notes that Forrester’s numbers did not include Web sites, e-mail or productivity desktop applications such as word processing. Custom applications that are legacy applications and those developed inside a company and then hosted outside were not included in the Forrester numbers.

GartnerGroup’s Dataquest says the ASP market will reach $22.7 billion in 2003. Dataquest defines the ASP marketplace as “the provisioning (and servicing) of business-process-enabling applications delivered over a network via a subscription-based outsourcing contract.”

“We are not including in this number providers of pure infrastructure, says Dennis Wayson. “That kind of thing would not be included because from our viewpoint that’s just infrastructure installation. It doesn’t become an application service provider until there is some application functionality being delivered across the platform.

“A lot of the ASPs are reporting revenue that is actually professional services revenue [consulting and systems integration revenue]; it’s not really revenue coming from selling transactions or seats on an application,” he adds. Wayson says that ASPs’ revenues are being boosted as they provide integration for customers to help them get up and running. In the future, he believes that the portion of revenues resulting from consulting and integration will decrease. “Right now,” he explains, “we’re counting those revenues that are really professional services revenues as part of the revenue stream of a given ASP.”