Here is the first of the two part seris. FrankC.
How Application Service Providers Will Change Your Life
By Jim Seymour
Special to TheStreet.com
6/28/99 12:58 PM ET
When Microsoft (MSFT:Nasdaq) rolled out its new Office 2000 productivity suite a couple of weeks ago at a bash in San Francisco, not all the celebrating was onstage and at the parties. Sure, Office 2000 is supposed to give Microsoft revenue growth a big lift -- even though, as I wrote here a month ago, this is not going to be seen as an automatic, no-brainer upgrade by Corporate America. And Microsoft, while hardly a beggar, needs to keep up its revenue stream from the applications side, as it tries to migrate its operating-system user base to Windows 98 and Windows 2000 (formerly Windows NT 5.0).
But the real partying in San Francisco was backstage, so to speak, because with Office 2000, Microsoft finally has in place what it thinks is the right applications product, with the right buried hooks, to begin to put a new software delivery and pricing system in place.
Dial-Up Software?
That system, which relies on a new class of resellers known generally as application service providers, is intended to move customers to renting Microsoft software, rather than licensing it, the present method. (You may think that when you pick up a copy of Windows 98 down at CompuMegaLand, you've bought it, but read the fine print and you'll find you've only licensed the right to use the software, on one PC, in limited ways. Ownership of the software itself -- right down to that shiny CD in your hands -- remains with Microsoft. Same thing with virtually every other shrink-wrapped software package "sold" in the U.S.)
ASPs -- a phrase you'll be hearing a lot over the next couple of years -- provide an alternative means of "buying" and using software. Instead of acquiring a copy of Program X by buying the package at retail, or buying, then downloading the code on the Web, you'll instead log onto your chosen ASP -- think about your Net-access ISP for a minute as an analogy -- and use the software, key parts of which reside on its servers. Your PC will have only some of the files, plus a token of authenticity that confirms to similar code on the server your identity as a paid-up subscriber to the software package. (Your data files live on your own PC, of course.)
Microsoft wasn't a minute too early in lining up Office 2000 as an ASP-ready product. Today's total market for office productivity suites, such as Office 2000, is about $7 billion; Forrester Research says the ASP market will be almost as large, worth about $6.7 billion, in just two years. Somewhat more cautiously, International Data predicts the applications outsourcing market alone will grow from about $150 million this year to $2 billion by 2003.
This approach has some advantages for some customers, and overwhelming advantages for every software developer.
On the developer's side, you're instantly converted from a one-time, or at least only very occasional, customer, who may buy version 3.1 of Program X and still be using it a decade later -- like all those Lotus 1-2-3 release 1a users out there who bought the software in the early 1980s and have never upgraded -- to a regular customer, producing a highly predictable revenue stream. (Yes, those 1-2-3 1a users really do exist. I run into them from time to time, and I hear from them in emails, frequently -- usually complaining that I and everyone else in the PC business have forgotten about them. Which we pretty much have.)
The developer also doesn't have to worry about supporting multiple versions of a product because now upgrading is automatic: The developer need only upgrade the "master copies" of the software on its licensed ASPs' servers, and bingo! All connected end-users are instantly using the latest version. No more supporting multiple code bases, old code or abandoned features, which translates into reduced development and support costs. (Don't like the new version? Want to continue using your present version? Tough.)
Sign Me Up
The ASP business thus not only creates a whole new class of businesses -- these ASPs -- but also regularizes developers' income, moving from a release-to-release, upgrade-by-upgrade, poverty-to-plenty-to-poverty-again cash-flow cycle.
Because as a customer, you'll typically pay a flat fee to "enroll," then a monthly fee to continue using the program.
For example, let's say your friendly local ASP offers you the full Office 2000 package for a one-time fee of $50, plus $9.95 per month thereafter as a subscription. You automatically get all upgrades, as released, new drivers, new help files, new features, everything, for that one monthly fee. (All ASP pricing here is hypothetical.)
Such a deal!
Now, instead of paying $250 to $300 to upgrade to Office 2000 from your current Office 97 package, you have an initial cash outlay of only $50 -- but a drip-drip-drip monthly nibble of 10 bucks. Over the course of 24 months -- a typical upgrade cycle now for major packages such as Office -- you'll pay $240 in monthly fees. Just for Office 2000.
And -- this is what software developers really love -- you have to keep paying, or you're cut off: no more Office 2000 for you, buster. No more of your freeloading by buying the package once, then using it for years without paying another dime ... you cheapskate!
If you came to computers as part of the PC revolution over the past two decades, this may sound pretty outrageous. But if you've been in the game longer, or deal with so-called enterprise software -- the huge packages on which medium to large businesses run processes such as HR records, inventory, billing, etc. -- you know this is nothing new. From the early mainframe days, most big-iron software has been licensed on a per-user (per-"seat") basis.
For a decade or more, PC software makers have wanted to get into this perpetual-motion machine. Microsoft and others have been offering "site licenses," based on the number of users, for more than a decade. But these have always been based on trust ... and the threat of litigation against companies that exceeded the number of licensed users, or that continued to use a package after choosing not to renew their licenses.
Now, the ASP idea allows software developers to accurately meter your usage -- and cut you off, if you don't pay up.
Getting on the Gravy Train
It will be some time before this model is fully in place, of course. We've been seeing moves toward "renting" larger-scale enterprise software for some time, since that's a more plausible jump. Big enterprise software developers such as SAP (SAP:NYSE ADR), Baan (BAANF:Nasdaq ADR), PeopleSoft (PSFT:Nasdaq) and others have been getting into the ASP groove over the past year.
And certainly the idea of renting software by the month can make sense for some users. Small businesses, for example, can get access to big-business-style packages they could never afford to license outright -- and could never afford to support. By licensing just a few seats' worth of these packages, accessed over the Internet, they gain access to tools they'd never have, at prices they could never afford, and can compete more effectively with the big boys.
Large businesses can get out of the business of rolling out both new applications and upgrades of existing ones -- an immense headache, inevitably marked by delays, soaring costs and unhappy end-users.
Indeed, those two benefits suggest what the ASP is really about -- an outsourcing business, allowing companies to back away from the high fixed costs and potential for projects spinning out of control on both deadlines and costs. Think of the ASP decision for a company as very much like any other outsourcing initiative -- a trend, of course, that's already reshaping corporate information technology planning and budgets around the world -- and you've got a handle on why companies are interested in application service providers' offerings.
From the customer's side, we also have to think about how patient users will be when they have to wait as the software downloads each time. Today's porky applications packages -- Microsoft Word and Excel, for example, or Corel's (COSFF:Nasdaq) WordPerfect, all among the early candidates, their makers say, for ASP delivery -- are much too large, I think, for even those on fast-access Net connections to put up with the download delays. But software developers say privately they can solve that by parking parts of an app on your PC's hard disk and only downloading the other parts through an ASP.
Whether they can or not, they certainly have an incentive to work on it: The regularizing of revenues and savings on distribution and support costs under ASP delivery of apps can be huge.
I think that for developers of PC software, persuading both corporate and individual customers to move to a rental model is going to be tough ... and slow. But I also think there's enough at stake here that they'll make a success of the idea.
For investors, the most interesting thing about this model isn't the tough road software developers face trying to persuade customers to switch to the ASP model, but the business opportunities ASP creates for those providing the middleman service -- the ASPs set up to actually interact with the software customers.
I'm convinced the ASP business is eventually going to be huge and will represent the next big wave in the software business.
As with earlier pairs of columns here on TheStreet.com on the fast-access wars and on the MP3 digital-music boom, I want to give you a kind of taxonomy of the ASP market: background, market realities, players and likely winners.
More on spotting the early players and probable long-term winners tomorrow.
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