Of all the Big Ideas spawned during the Internet boom, perhaps none blossomed so promisingly yet wilted so quickly as that of renting enterprise software over the Web. By some accounts, upward of 1,000 self-proclaimed application service providers, or ASPs, were launched during 1999 and 2000, with venture capitalists betting more than $1 billion on the seemingly foolproof but unproven business model. Within two years, the great majority of those start-ups fell victim to their own hype, leaving investors in shock and the ASP model widely repudiated as an inherent loser. In many minds, the term ASP came to mean “a stupid proposition.”

Lately, though, the notion of handing over the installation, administration, maintenance, and delivery of large-scale, mission-critical software to specialist outsourcers has been showing surprising signs of life. Tweaking their business models and acquiring smaller rivals to build mass, several of the original ASPs have emerged from the gloom as promising and even profitable outfits.

Surebridge, for instance, has been in the black since mid-2002 and, with help from two acquisitions, saw its first-quarter 2003 revenues leap 87 percent above those of a year earlier. Leading suppliers of enterprise software, such as IBM, Oracle, and J.D. Edwards, have been enjoying considerable success with captive ASP efforts. And such major corporations as Kinko’s, NBC, and Rohm and Haas have turned to ASPs for help with vital applications like financial accounting, messaging, and human resources.

“Choosing to use an ASP is no longer as much of a mental hurdle for CIOs or CFOs,” says Amy Mizoras, a program manager who tracks the resurgent ASP sector at market researcher International Data Corp. “The ROI and payback are [now] proven.”

Just ask RiverBend Medical Group, a western Massachusetts group practice with 85 physicians. It did away with most of its in-house IT staff and now relies on two ASPs: Surebridge for a set of Microsoft’s financial applications and The TriZetto Group for medical-practice software. “The capital investment to do all this ourselves would be very high,” says Michael Callahan, RiverBend’s CFO. Using ASPs “gives us a huge advantage because we have many other things we can use that capital for.”

IDC estimates that worldwide spending for software deployed as a service is currently growing at a compound annual rate of about 30 percent, from $2.3 billion in 2002 to an estimated $8 billion in 2007. IDC’s calculations cover not only the hosting by ASPs of traditional applications but also Web-native applications (software created specifically to be sold in an ASP model — see story below) and the emerging genre of so-called hosted Web services applications, which typically entail the provision of isolated software functions that augment or are combined into full-blown applications.

While the past few years have been tumultuous, there is now a solid case to be made for ASPs. According to Mizoras, a study of 52 companies well along in their use of ASP services found that they were attaining an average five-year ROI of 404 percent. A good deal of that sizable return derives from substantially improved business processes in both IT and the firms’ core activities. The average total cost savings over five years, measured solely in terms of hard-dollar IT expenses such as hardware purchases, software maintenance, and training, works out to a solid 19 percent.

One major driver behind the ASPs’ newfound success: the growing complexity of enterprise software, which is fast outstripping many midtier corporations’ ability to keep up. Besides the push to integrate different applications so that they smoothly exchange data, there’s the growing requirement to make them available through PCs, Web browsers, and even rich-functioned, customer-specific Web portals. Building all that on top of old-style, terminal-based software creates a tremendous strain, because suddenly there are myriad more moving parts, each one evolving along its own path and at its own pace.

“Their Problem, Not Ours”

“From the standpoint of the CIO, it’s a great comfort to have experts working for you who deal with that kind of technology all the time,” says Mark Federle, CIO at The Weitz Co., a $750 million general contractor in Des Moines. Weitz licenses its ERP package from J.D. Edwards but hosts the software through WTS Inc., a Seattle-based ASP.

Federle says that fixed IT costs were a major selling point: its contract ensures that Weitz will pay the same monthly fee for the next three years, even if the company reaches its goal of nearly doubling in size during that period. “If they need to add disks or memory to the servers to handle the extra load, it’s their problem, not ours,” says Federle. “Technology is one of the most variable costs you face, but I can assure our CFO that it’s fixed for three years or more.”

Also working to the ASPs’ advantage is a growing realization that even the most expensive software provides little competitive differentiation. Says Joshua Greenbaum, head of Enterprise Applications Consulting in Daly City, California: “It makes as much sense to own [various core] applications as it does to write your own payroll checks. There’s a large and growing body of software functionality to be handed off” to hosting companies.

While obviously similar in concept, this handoff is not nearly as extensive as the all-encompassing IT outsourcing deals pioneered 20 years ago by Electronic Data Systems, Computer Sciences Corp., and IBM, for instance. Their offer to the likes of J.P. Morgan, Eastman Kodak, and Xerox was to essentially buy entire data-processing departments — including mainframe data centers and thousands of programmers, technicians, and support staff — and thereby greatly improve the customers’ balance sheets. It was not uncommon for billions of dollars to change hands in these deals.

In contrast, ASPs like Corio, Oracle, Surebridge, and USinternetworking (USi) offer only to manage and provide access to selected software packages — a financial accounting system, say — and to do that under contract for a fixed monthly fee of so many hundreds or thousands of dollars. In most cases, the customer still owns and pays for the license to the software product — a far cry from the early days of ASPs, when the vendors bought the software and tried to amortize it over time and across multiple customers.

Today, customers buy the software as usual but pay the ASP to install, configure, operate, monitor, troubleshoot, and regularly upgrade the program, as well as provide related services such as training, 24-hour help-desk support, and disaster recovery. ASPs typically own the processors, storage, and networking gear needed to run their clients’ software and connect to clients’ offices and road-warrior employees via the public Web or leased high-speed telephone lines. And with some contracts, fees remain fixed no matter how much the customer increases its usage of the hosted software.

It’s only because each ASP specializes in a limited number of software titles that this kind of “apps-on-tap” business model has any chance of being profitable. Beyond providing raw computing oomph, the cost of which is steadily falling anyway, the ASP’s fundamental value is the ability to provide scarce technical expertise at an affordable price, even as the complexity of deploying and maintaining high-end software rises.

To be able to leverage their technical teams across multiple customers, therefore, ASPs’ main challenge is to devise efficient IT-related business processes and tools: automated schemes for quickly configuring and installing new copies of a software package, for monitoring and fine-tuning the software’s performance, and for applying software makers’ patches and updates rapidly and accurately. “We have to provide some [superior] level of consistent process,” says Mike Harper, senior vice president, ERP product area, at USi.

In short, today’s ASPs are older, wiser, and battle-tested, which should give prospective customers far more confidence. But they continue to live in interesting times and will need to leverage every ounce of insight they’ve gleaned in order to succeed.

Sidebar: Model Behavior

The application service provider (ASP) model has gotten substantial validation in part from new software companies created around the idea of operating as a centrally hosted service versus a traditional you-buy-it, you-run-it model. The two flagship examples of this are SalesForce.com and UpShot. Each has designed its own software for Web delivery (across even slow, dial-up connections) to salespeople located anywhere in the field. All they need in a hotel room, say, is a phone line, a modem, and a Web browser on their laptop PC.

UpShot and SalesForce.com make no claims of matching all of the advanced functionality available in customer relationship management software from market leaders such as Siebel Systems, but they’ve achieved success by providing most of the features that most of their target customers actually need and regularly use. Now dozens of new companies have followed this model, offering services ranging from E-mail marketing (and its rival, spam-blocking) to broader business processes such as merchandise return.

Not that all is rosy. Customers must often choose between an ASP that manages software made by someone else and the vendor itself, which may sell through an ASP model. Oracle has been particularly successful in winning business by acting as its own ASP, says Joshua Greenbaum, head of Enterprise Applications Consulting.

That may force independents back toward the breadth-of-offerings approach that seemed to be one of their more acute growing pains. Surebridge, for instance, acquired ManagedOps, which hosts Microsoft Business Solutions applications for medium-size businesses, and Transchannel, specializing in PeopleSoft applications. Those acquisitions helped it reach the 1,000-plus customer mark. BlueStar, specializing in hosting SAP software, acquired Agilera, which previously had absorbed niche player United Messaging.

But the boundaries of competition can be difficult to assess. ASPs continue to work closely with software makers to win new customers, jointly making sales calls and defining new software features. Surebridge and others are also seeking additional distribution channels in the form of IT and management consulting firms and companies that outsource entire business processes.

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