Can't win 'em all, but I hope this new helps you guys out....
(I got it off RB today)
ASP And You Shall Receive
May 7, 1999 - 10:30 AM
By Nathan Beckord
- Chat with Nathan on his message board.
Over the past few months a noticeable buzz has been building in trade magazines and on Internet bulletin boards about the emerging Application Service Provider, or ASP, market. International Business Machines (IBM), Electronic Data Systems (EDS) and USinternetworking (USIX) are among the companies seeking to make headway into this new outsourcing industry.
The concept is fairly simple: companies "rent" complex and expensive software on a monthly per-user basis rather than buying it outright. Software such as enterprise resource planning systems, procurement applications, human resources software and corporate finance applications is run and stored on hosting firms' servers or dedicated web farms. Users then access the applications through web browsers or alternative thin clients.
The Players
IBM's first-quarter results were boosted by strong growth in software and services, part of which came from outsourcing revenue. In 1998, the company accrued between $300 million and $400 million from applications outsourcing - still a small portion of overall services revenue, but possibly indicative of things to come. True to its conservative nature, the computer giant is moving cautiously into the outsourcing market. Big Blue began piloting hosting services overseas through arrangements with Oracle (ORCL) and German software maker SAP (SAP). Those followed earlier agreements with J.D. Edwards (JDEC) and Great Plains Software (GPSI) to provide financial applications hosting to small and mid-sized companies. Meanwhile, Oracle's long-heralded network computing vision appears to be finding life in the form of the Oracle Business OnLine networking system, which will allow customers access to Oracle-hosted applications and databases from secure Web site addresses.
Electronic Data Systems has also aligned itself with SAP, and is targeting mid-sized companies with an outsourcing service that manages SAP R/3 manufacturing, financial, sales and logistics operations. The package is not yet a full R/3 suite. It doesn't include human resources, business warehousing or supply chain applications, but those are expected later this year.
Following on reseller agreements with Computer Sciences Corp. (CSC) and KPMG Peat Marwick, SAP competitor PeopleSoft (PSFT) recently made an equity investment in ASP startup Corio. PeopleSoft and Corio have begun drafting plans for a joint research and development deal. Corio, which is expected to go public later this year, rents packaged financial, human resources and manufacturing applications, which are hosted on server farms run by Exodus Communications (EXDS) and other firms. Earlier this year, Corio announced a partnership with former push software darling Marimba (which recently filed to go public). Corio will use Marimba's Castanet push software for delivering, managing and remotely updating applications over the Internet. Long in search of a use for its push technology, Marimba may have found it in the ASP market.
Corio's primary competitor is USinternetworking, whose shares went public in April. USinternetworking stock quickly traded as high as 60, only to drop just as quickly to 31. The shares have since crept back to the 40 range, helped by strong first-quarter results and a rash of analyst coverage. USinternetworking boasts alliances with Sagent Technology (SGNT), Cisco Systems (CSCO), Broadvision (BVSN) and Siebel Systems (SEBL), as well as PeopleSoft.
After firmly establishing a leadership position in the Web site hosting business, USWeb (USWB) has begun looking towards the ASP market for incremental revenue opportunities. First up will be outsourced supply chain management, shipping and corporate requisition offerings. Later this year, the company is expected to announce marketing, call center and sales force automation services, with plans to eventually offer enterprise resource planning, or ERP, tools. USWeb's positioning may prove to be a boon as enterprise operations become increasingly integrated with customers' e-commerce strategies.
Additional companies involved in the ASP market include Ciber (CBR) and Futurelink (FLNK). Ciber is an information technology services and consulting firm with a newly-announced ERP outsourcing practice. Futurelink is an ASP, which targets the lower end of the market. The company offers stand-alone enterprise applications such as contact management and accounting software from vendors Great Plains, Applix (APLX) and Onyx Software (ONXS). Planned services include consumer applications such as Microsoft Office and the outsourcing of a small firm's entire IT department. Futurelink's shares have traded as low as 24 cents each on the Over-The-Counter Bulletin Board, but recently crossed the $1 mark on relatively heavy volume. The number of shares outstanding, estimated at around 100 million, remains a concern.
Finally, private companies to watch include Sage Networks (which acquired Lotus Notes hosting firm Interliant and has filed to go public), ServiceNet, World Technology Services, and Infowave Technology.
Outsourcing Advantages
I've long been a fan of IT outsourcing, as evidenced by my first two Raging Bull articles which delved into outsourced Web hosting, security and e-commerce. I borrowed from those articles to comprise a list of several of the more advantageous facets of outsourcing that also apply to the ASP market.
Emphasis on core competencies - By outsourcing as many non-essential functions as possible, companies are able to focus on what they do best - whether it's designing the latest and greatest processor or distributing snack food.
Reduced software costs - By renting rather than buying high-end applications, companies can avoid large up-front software capital expenditures and cut the total cost of application use through reductions in the requisite hardware and support staff expenses. Estimates of the potential cost reduction afforded by outsourcing major applications run between 20% and 40% savings per computing desktop.
Managing technological change - Outsourcing applications ensures that companies can use the most up-to-date software. The responsibility of maintaining and upgrading systems is passed on to the hosting firm, which is compelled to do so lest they lose competitive advantage.
Scarcity of IT Talent - A search on any job related Web site reveals a severe shortage of skilled IT professionals. Traditional manufacturing firms have found it difficult to retain qualified technical staff. The reasons are fairly transparent: if you were a hot-in-demand database programmer, for example, would you rather work in the back office of a widget manufacturing firm, or be at the locus of your trade by working at a leading ASP?
Several general technology trends also bode well for the ASP market.
After years of requiring substantial custom coding and integration, business application software is becoming an increasingly standardized commodity, a trend which facilitates the growth of the rental market.
ERP vendors have seen their share prices hit hard lately due to a slowing market and the distraction of Y2K and e-commerce services. However, players in the field - SAP, BAAN, Siebel, Peoplesoft, Oracle, etc. - are smart, aggressive and cash rich companies looking for avenues which will help them return to formerly high growth rates. The ASP model as a new distribution channel may well fit the bill.
There is still a decent-sized market of large companies which desire the rich functionality of ERP systems. Analysts estimate that the market among large firms is roughly 50% saturated. The market for ERP software has been around for awhile, so if we assume that perhaps 25% of large companies intend to develop such applications internally or intend to do without them altogether, that still leaves 25% of the large-firm market which may want ERP systems but has been slow to adopt (for a variety of reasons, many of which are addressed by ASPs).
Perhaps more enticing is the still largely underpenetrated market of small and mid-sized companies, generally defined as having revenue of less than $250 million and fewer than 200 users. These firms desire the functionality of ERP systems, but have neither the upfront money nor the IT support infrastructure to handle them. Enter the ASP pay-as-you-go pricing model.
Finally, traveling employees and the growth of telecommuting bodes well for the ASP industry. By making applications available on the Web through secure channels, traveling employees can access programs while on the road (for example, sales people could access sales force automation products through a Web browser or through future alternative devices, such as PDAs or cell phones). It's estimated that 30 million to 40 million telecommuters and at-home workers stand to benefit via increased remote access to ERP business applications.
ASP is not an investor's utopia. There are hurdles that will slow the market's ascent, including bandwidth limitation. Running an ERP system over a LAN is still somewhat slow, and placing more distance such as Internet connection between the server and end user will make things even slower. Fault and liability issues also are likely to crop up if the hosting ASP suffers service failures or outages, and concern over ongoing support may arise in the event of an acquisition or restructuring of the ASP. Perhaps most importantly, the sensitive nature of the information that is stored in ERP systems - financial data, manufacturing knowledge and so on - will limit the ultimate market size, because many companies won't want that information to reside outside their corporate systems. Finally, although ERP vendors have been aggressively partnering with hosting ASPs, there is the possibility that they will eventually want the whole pie and move to host the applications themselves, as in the case of Oracle.
ASP's Potential
The ASP market should create some fairly attractive business models which provide solid investment returns over the next several years, though few will likely be dramatic homeruns. It may be appropriate to view ASP as a new branch of the ERP market, which in the early 1990s created a stable of companies which became prized institutional holdings. Shorter installation and sales cycles, however, mean the ASP market may grow even faster than ERP did, and outsourcing firms are further blessed by a recurring revenue stream, compared with the sometimes erratic high-margin software models of the ERP vendors. The fundamental drivers are in place and the market appears poised to accelerate through additional EDS/SAP-type deals as well as through increased awareness as ASP companies go public. Analyst estimates of potential market size vary, but predictions of $6 billion in ASP sales by the year 2001 do not seem unreasonable.
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