Empty server racks in data centers
Hosting glut should mean bargains for companies
By JENNIFER MEARS AND DENISE PAPPALARDO
Network World, 07/09/01
Empty server racks line the walls of data centers throughout the U.S., casualties of a gold rush that never quite materialized.
In the past few years, hosting service providers were joined by telecom companies and real estate investors in building what many believed would be the mother lode of the Internet boom: concrete, windowless warehouses with biometric security, raised floors and temperature controls to house rapidly proliferating network and data center equipment.
How times have changed.
Now collocation is available at bargain prices as service providers seek to fill millions of square feet of idle data center space. In a June report, CIBC World Markets analyst Stephen Murphy writes that price wars are already under way in the collocation market "and will only accelerate . . . over the remainder of 2001." He says users can expect collocation price cuts of about 30% per year for the next few years.
Quite a switch from 1999, when industry experts predicted demand would outrun data center capacity by the end of 2000. That forecast resulted in the rush to build, with nine million square feet of data center space added to the three million in place. Only 1.8 million square feet of that new space got used, he says.
The lull is due in large part to the demise of the collocation market's two biggest customer segments: dot-coms and application service providers, analysts say. In 1999, for example, IDC predicted the collocation market would hit $4.2 billion by 2003. A report released at the end of last year (and the most updated numbers IDC has available) now says 2003 revenue will be $3.2 billion, a drop of more than 20%.
Cutting back
Many service providers are curtailing building plans because of the data center glut. AT&T , for example, postponed the opening of three data centers, two in Boston and one in Austin, Texas, until 2002. Genuity cut capital expenditures for the next three years by $5 billion. And Exodus slashed its capital expenditure budget by $300 million for this year, deciding not to open a data center in Munich.
Despite the cutbacks, Murphy predicts 78% of 18 million square feet of data center space will go unused by year-end.
Commercial real estate services firm Grubb & Ellis looked at a wider section of data center space, reviewing 46.5 million square feet of telecommunications real estate facilities that it defined as "carrier hotels, collocation facilities and data/cyber centers that were more than 75% dedicated to these uses." It found the vacancy rate in those facilities at the end of the first quarter of this year was 44.6%, compared with the national, office vacancy rate that was just above 10%.
The softening market puts collocation users at an advantage. Dwight Gibbs, CTO at multimedia personal finance company The Motley Fool, for example, says he's in a great position to shop around because his collocation contract with Exodus is expiring soon.
"People are definitely dealing, there's no doubt about it," he says. "Like any good business, when you can cut a better deal, you go out and try to get a better deal."
Michael Caspar, CTO at SirenServ, an online content provider, is in a different situation. He's buying managed hosting services from Verio, and he's happy with the service he's getting.
"There is a huge cost associated with changing hosting services. Because we use dedicated hosting and not collocation, the cost for us [to move] would be higher," he says. "It's not like we could just go pick up our hardware and move it somewhere else. Even if we were unhappy with Verio, the pain and agony associated with switching isn't worth the effort right now."
That's the kind of thing hosters like to hear, and one of the reasons why hosting providers are making the transition into managed services.
According to The Yankee Group, collocation brings in $15 to $25 in revenue per square foot. Add some additional services such as managed firewalls and performance monitoring and revenue jumps to between $60 and $75 per square foot. Pure managed, "lights out" offerings, which analysts say companies are looking for more and more, can bring in revenue of $200 to $300 per square foot.
"Space is only one component of the managed hosting solution that we are selling, and our customers rarely make a purchase decision based on the price of space," Exodus CEO Ellen Hancock said in a conference call with financial analysts last month. "Our customers are looking for integrated managed hosting solutions and are willing to pay a premium for the unique value that Exodus offers."
Analysts say price pressures probably won't translate into lower-cost managed services, but Caspar says he's seen some prices at Verio drop.
"We just recently upgraded all of our servers and aren't paying any more for the newer machines with double the processors, memory and disk space than we were for our old, 'slower' servers," he says.
Companies should be aware of the shift in the market from collocation and take advantage of price pressure where they can, says Joel Yaffee, senior industry analyst of Internet infrastructure services at Giga Information Group. As the market moves toward managed services and carriers, and bigger players such as IBM get in on the action, there will be more consolidation, he says.
WorldCom spent $6.9 billion to acquire Intermedia to get controlling interest in Web hosting service provider Digex because WorldCom did not create a successful managed Web hosting business on its own.
Genuity, on the other hand, opted not to build its own data centers internationally. Instead, it is in the process of acquiring Integra, a managed hosting provider with data centers in six European cities.
Corporations "need to keep contracts short-term; they need to leverage the uncertainty about some of the smaller players to their advantage. The smaller guys have always provided better technical capabilities, and now you can get even better pricing from them because you know they're hurting for business," Yaffee says.
Melanie Posey, program manager of Web hosting at IDC, says an overcapacity in data center space doesn't necessarily mean big trouble for companies that can provide higher-revenue-generating managed services. Companies that offer nothing more than real estate, however, like Colo.com, which filed for Chapter 11 bankruptcy in May, have nowhere to go but down, she says.
But even Exodus, which has gained big managed-services customers, such as American Airlines and Adidas, has been struggling financially as it tries to move from its collocation foundation.
This move is critical for Exodus and its competitors because this much is clear: Plain vanilla collocation won't do anymore.
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