How Application Service Providers Will Change Your Life, Part 2

Sorting out the early players in the ASP racket.
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Yesterday we walked through an overview of the application service provider approach to delivering software, a market I think is going to emerge over the next couple of years as a big part of the corporate software business.

ASPs allow computer users to connect to a server maintained by the ASP and use one or more programs from that server for a monthly, quarterly or annual fee. Part of the application remains on the user's PC (along, usually, with all data files); the rest is on the ASP's servers. An authorization process checks each time the user tries to bring up a given program, to make sure his account is current.

This turns software publishers' customers into steady monthly or quarterly sources of revenue while producing lower net costs for the developers. It's easy to see why software companies are excited about the ASP approach -- if software resellers, both the bricks-and-mortar kind and the online outfits, are less so.

Lots of companies are going to benefit along the food chain of the ASP software-licensing model. They will include hardware shops --

Dell

(DELL) - Get Report

,

Hewlett-Packard

(HWP)

,

Compaq

(CPQ)

,

Sun

(SUNW) - Get Report

,

Cisco

(CSCO) - Get Report

and the like -- that'll sell boatloads of servers, routers and other boxes to ASPs; resellers of fast-access connections to the Web; and, eventually, the software developers themselves, who believe they'll earn a significant part of their revenue from ASP'd software packages.

The former will be a thin gruel for some time to come, because ASP-related revenue is going to be only a very small part of the bottom line for the big PC and communications hardware companies in the near- to midterm future. Ditto the bandwidth providers. And while the developers will win big if they succeed in establishing the ASP model, it's going to be even longer before revenue increases markedly from this sea change.

It's the guys in the emerging middle -- the new ASPs setting up shop, the existing entities adding this line of business and the joint ventures between established companies now being formed to exploit the ASP opportunity -- that look most promising to me.

ISPs Reach Out

Look, for example, for the larger national ISP shops to turn to ASP services as a logical line extension. They already have the T3/OC3c/OC12c phone lines, and rooms full of servers in place and experience managing them. It's an easy play for them.

For example,

Verio

(VRIO)

, the Denver-based ISP that has been doing a roll-up across America, gobbling up local and regional ISPs, has already announced ASP plans. Verio now hosts about a quarter of a million Web sites and provides ISP service in 41 metro areas. Expanding to applications hosting is a relatively easy step, especially given Verio's relentless focus on selling ISP services to businesses, not residential customers.

And

Concentric Network

(CNCX)

, an emerging power in retail and wholesale ISP services and Web site hosting, two weeks ago announced a deal with

Microsoft

(MSFT) - Get Report

to begin hosting Microsoft Exchange and other Microsoft BackOffice software for corporate clients.

Similarly, I expect to see outfits like

Mindspring

(MSPG)

,

Earthlink

(ELNK)

and other ISPs jump in shortly.

Hosting companies, which now draw revenue from managing server farms for corporate Web sites, are another class of obvious ASP players.

Exodus Communications

(EXDS)

, the Web-site hosting company run by former

IBM

(IBM) - Get Report

and

Apple

(AAPL) - Get Report

whiz Ellen Hancock, is a good example. Exodus is already growing like wildfire; with 13 data centers open now and eight more due by year-end -- and with enormous credibility as a proven supplier of hosting services to large corporations -- Exodus is well positioned to grab a lead in application hosting as well.

I expect to see Exodus announce plans to offer ASP services very soon.

The Semipure Plays

About a half-dozen companies have been formed, or re-formed, specifically to serve the ASP market. Some of the most interesting for investors:

USinternetworking

(USIX)

, which went public in April and soared to 60 on opening day (it has since fallen by about half), set out to build a worldwide network of high-tech data centers before it realized ASP offered a complementary revenue stream to increase the return on those high-priced centers. Now USinternetworking is essentially rebuilding itself to be a power in the application service provider world -- and building the right kind of partnerships for that world.

USinternetworking has allied with

U S West

(USW)

to jointly offer USinternetworking's iMap electronic-commerce suite in the 14 Western states. U S West has also taken an equity stake in USinternetworking. (Despite its rep for lousy service and poor management, U S West is probably the regional Bell farthest ahead in adding ASP services to its offerings. For example, U S West has been hosting

Lotus

Notes and Domino apps on a "rental" basis -- ASP before we started calling it ASP! -- since 1996.)

All this makes USinternetworking my present favorite among the public ASP-focused companies.

One of the purest plays is 2-year-old

Corio

. By focusing on enterprise resource-planning software, or ERP, Corio has tackled one of the most popular, but also most expensive and complex, areas in the corporate software market. ERP apps, such as those made by

SAP

(SAP) - Get Report

,

Baan

(BAANF)

and

PeopleSoft

(PSFT)

, lend themselves particularly well to ASP distribution.

Predictably, PeopleSoft has made an equity investment in Corio, which is a big chip when Corio approaches customers. Corio closed a second $21 million round of funding in May, led by its original venture-capital firm,

Kleiner Perkins Caufield & Byers

.

One test will be how successful Corio is at joining to basic ASP delivery service the implementation-consulting services client companies require to bring PeopleSoft (and other ERP packages) up in their environments.

Watch for a Corio IPO later this year, assuming the IPO market comes back some. Corio smells like a winner.

Boston's

Breakaway Solutions

has been following a path similar to that of USinternetworking, building data centers in Boston, New York, Santa Clara, San Jose, St. Louis and Washington, as well as in London, Melbourne, Singapore and Toyko. More recently it has been acquiring companies it needs to offer ASP services, as in its purchase two weeks ago of

WebYes

, an early player in the ASP wars. WebYes had built its rep as an implementer of Sun's NetDynamics Enterprise Application Server, one of the key pieces of software in building ASP systems.

Another relatively pure play, Canada's

FutureLink

(FLNKD)

, which likes to pitch itself as "the world's first utility computing company," says about $4 million of its forecast 1999 revenue of $11 million will come from ASP sources. But "all our future growth will come from the ASP side of the business," FutureLink CEO Cameron Chell says.

FutureLink was one of Microsoft's first choices as a partner for its ASP tests last year; two months ago it went commercial, offering Microsoft Exchange and SQL Server to its ASP clients. FutureLink leveraged its early experience as a Microsoft testing partner into a most-favored-nation deal under which it pays Microsoft a monthly licensing fee based only on the number of servers actually used in the preceding month to serve its ASP customers.

FutureLink earlier this month acquired California's

Micro Vision

, which has been the leading U.S. reseller of

Citrix's

(CTXS) - Get Report

WinFrame and MetaFrame Windows NT operating system add-ons, which undergird FutureLink's ASP delivery system.

The company, which crept into the public markets by buying a dormant over-the-counter shell, has a tiny market cap -- under $100 million, less than a tenth that of USinternetworking -- and trades at about $6 a share. That price popped up from FutureLink's usual $1-or-so price in early June, after a 1-for-5 reverse stock split intended to earn some respect for the company in the markets.

The Giants Jump In

Even the big guys are turned on by the potential profits of ASP. IBM's Global Services division has begun by signing up

Great Plains Software

(GPSI)

, a leading accounting-systems vendor, to deliver its Great Plains' Dynamics financial-management system as an ASP product over IBM's networks. Great Plains is going to use its existing network of VARS and CPA firms as "feet on the street" to sell the jointly delivered service.

Perot Systems

(PER) - Get Report

and

EDS

(EDS)

are jumping in, too -- EDS with an oddball "wholesale ASP" system which allows smaller firms, such as ISPs, which are eager to get into ASP, to sell the service but deliver the apps-hosting over EDS' network.

And as noted

here last week,

Qwest

(QWST)

and

KPMG

have created what is likely to become an early high-profile player: the joint venture,

Qwest Cyber.Solutions

, to deliver ASP services over Qwest's network. KPMG will help businesses set up and manage their ASP software access. The joint venture starts out with 450 experienced ASP consultants from KPMG's practice, plus seasoned management from both companies -- and $400 million in ASP contracts already in hand.

The regional Bell famously in

play these days, U S West, is another good example of a company reorienting itself toward the ASP era, on a large scale. It has created a Business Alliance Partners program, to ally itself with respected firms which can provide U S West business customers the additional help they'll need to set up and use ASP-hosted software applications.

Deloitte Consulting

has signed on as the first Business Alliance Partner for U S West.

The Hidden Middle Market

A substantial "hidden" market opportunity for services companies which can help corporations implement ASP software use is appearing. The Deloitte agreement with U S West is one example. Another is

Hunter Group

, a subsidiary of

Renaissance Worldwide

(REGI) - Get Report

, which has partnered with USinternetworking to help the latter's ASP customers get up and running with PeopleSoft applications.

The big consulting shops are all racing to build ASP-related ties to broadband carriers and big software companies.

And since the RBOCs are likely big-time players in the ASP role, they'll be fertile ground too for partnerships and consulting contracts for the middle-market shops.

Bringing up all but the simplest software packages under ASP delivery requires a fair amount of implementation expertise -- and the big enterprise resource planning packages, such as those from SAP and Baan, require enormous amounts of implementation work -- so this layer of "ASP implementers" is going to be a rich market, too.

Potholes Along the Way

This market is headed for explosive growth ... but not right away. At least three big problems remain to be solved:

  • Application Bloat. It's just not practical to deliver, time and again, whole apps to customers over the Net when those apps run many megabytes in size. No one has fast enough Net access for that. So software vendors still have to trim down their offerings substantially. We're still far from the kind of "thin client"-size apps which will work best under ASP.
  • Customer Price Resistance. In my experience, large companies see the cost savings from outsourcing via ASP pretty quickly, but midsize to small companies are much more resistant -- just as those companies often misapprehend other forms of outsourcing as an unneeded expense. And of course, consumers will go through the roof over this idea, seeing it as a gouge. Change is always a hard sell.
  • Stasis. Apart from specific customer issues with ASP access to software, both the software vendors and the emerging ASP industry have to overcome that general and debilitating inertia which grips us all. If it works fine the way things are now, why change? Again: serious missionary work ahead.

Clouds on the Distant Horizon

There is one potentially very dark cloud hanging over the ASP business. It worries execs at ASP companies, who either refuse to discuss the idea, or slip into sometimes-funny platitudes about how the threat simply doesn't exist.

Call it the

Microsoft Factor

. The problem is simple: The big software companies don't really need the new ASP outfits that they're cozying up to right now in an effort to get ASP off and running. No one seriously believes Microsoft, for example, couldn't bring up its own ASP network in short order. By doing so, it would cut out the ASP middlemen, draw closer to its customers -- and pocket a lot more of the revenue.

Similarly, Lotus doesn't need ASPs for 1-2-3 and its other SmartSuite productivity apps, or for Notes or Domino Server, etc. It can tap plenty of large-network management and apps-serving expertise from parent IBM -- and keep a much bigger share of the revenue from its ASP'd software.

This doesn't hold all down the line -- the smaller Great Plainses and PeopleSofts of the business do need network-hosting partners -- but it could certainly be true for companies with the size and clout of, say, SAP or Baan. Lease some network capacity from Qwest,

Williams

(WMB) - Get Report

or

Level 3

(LVLT)

, and they're in business, with Sap.net, Bann.net, and so on.

Right now, even the biggest software companies do need these partnerships with ASP companies old and new. There's market building to be done, and the software developers want to focus on ... well, software development, and leave the missionary work to others. They're happy to share revenue ... for now.

But in a couple of years? Three years? Will Microsoft really be willing to go on sharing revenue with ASP shops around the country, when it already has the bones of an ASP network in place with MSN?

"Ohmygosh," one exec of a new ASP company told me last week, "they'd never do that!"

Right...

Deja Vu All Over Again

Finally, if all this downloading apps as they're needed sounds faintly familiar to you ... you have a good memory. There are echoes here of the "Net PC" and "NC" boomlet in middecade, which seemed likely to become the poster child for Java.

Aside from the Java revolution's many other problems, the notion of cheap, relatively dumb computers that would rely on their links to a central machine for applications was undermined by the Darwinian evolution of the PC market. You can today buy excellent

smart

PCs for the $800-$900 NCs were going to cost, without the unbreakable tether to the mother ship.

ASP enthusiasts hate the NC analogy. It's still too fresh a wound, and to be fair, the analogy is more than a little skewed.

But it should provide a reminder for everyone involved in this about-to-emerge market -- and for would-be investors in ASP-related businesses -- of how different things sometimes are in the real world than the way they were in the offsite corporate retreat that cooked up The Plan.

ASP looks to me like a big, big winner in the years ahead, and as more companies embrace outsourcing, ASP is going to make new fortunes, both for traditional computer hardware and software companies and for the start-ups that get it right.

So often in business we misapprehend opportunity as danger and retreat in fear or freeze, like deer in the headlights of an onrushing car. Heck, I used to have a speech on that theme for corporate management. But in new, untested markets, there

is

danger in many opportunities.

Step carefully.

Jim Seymour is president of Seymour Group, an information-strategies consulting firm working with corporate clients in the U.S., Europe and Asia, and a longtime columnist for PC Magazine. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, Seymour was long Qwest Communications, although positions can change at any time. Seymour does not write about companies that are consulting clients of Seymour Group, or have been in recent years. While Seymour cannot provide investment advice or recommendations, he invites your feedback at

jseymour@thestreet.com.