RIP for service providers? Not so fast!
Fast forward a year, and that picture looks mighty simplistic. Even ASP darlings, like Corio and Critical Path, are struggling. Market analysts are predicting that 60 percent to 80 percent of ASPs could fail in the next year or so. Neither the overall economy nor the mood on Wall Street is helping fledgling ASPs.
Our work with small and mid-sized enterprises, however, reveals that there are elements of the xSP value proposition that resonate with executives, particularly those in mid-sized companies. We believe, however, that a fundamental shift from providing applications to providing management services is needed. A focus on delivery in these areas can help entrepreneurs be successful despite the gloomy environment.
Focus on the economic impact
Mid-sized companies represent the most attractive target segment for network-based services, as they are large enough to require robust infrastructure but typically lack scale to outsource IT functions to traditional system integrators, like IBM or EDS. These companies are also aggressively moving to broadband connections (T1- or DSL-based) that facilitate remote services.
From an economic viewpoint, two dimensions influence the decision to adopt network-based services (vs. implementing internally): 1. Absolute savings garnered through outsourcing. 2. Relative importance of the functionality to the corporation.
The first dimension is the traditionally highlighted measure of the xSP proposition. For example, remote email services may advertise a savings of 65 percent over the cost of using a local exchange-type server.
The second orthogonal dimension captures the overall impact of the savings on the corporate bottom line, as measured by the percent of total IT spending involved in provided the service. Only by combining the two dimensions is it clear which services offer truly compelling economic savings to enterprises.
Despite the focus of many ASPs on business applications, it is surprisingly the oft neglected and less-racy applications, such as desktop and server management, that offer some of the most compelling economic savings. Conversely, the total savings for most companies from seemingly hot areas such as outsourced data storage are small, with exceptions for some very fast-growing or very data-intensive companies.
Solve the mid-size company skill gap
Web hosting highlights the importance of addressing the skill gap. It can lead to significant absolute savings (think of economies of scale with server farms) but overall involves relatively low IT spending for the typical (non dot-com) small or medium business. As a result, the total economic impact of outsourcing is moderate for many mid-sized companies. What is driving the clear trend to adopt fully managed hosting among mid-sized companies? In our discussions, company executives consistently pointed to a lack of critical web management skills.
Many small and medium sized companies have trouble hiring and retaining critical IT staff. This lack of skills is the most important driver of xSP adoption, stronger even than economics. The skill gap is particularly prevalent in areas requiring network- or Web-based technologies. Opportunities therefore abound in areas like LAN management, WAN management, security, Web site setup and maintenance.
Work with company fears of security and control
Both IT and business executives find it difficult to entrust their desktop or corporate application data to a third party due to concerns around security, loss of control, and service reliability. The current market environment and the possibility of losing their data should an ASP fail are exacerbating these fears. While not always rationale, these fears can be difficult to overcome.
Some ASPs as well as new market entrants are addressing these needs directly by allowing companies to maintain their data on-site and, at times, as part of their original application. This new xSP model, typically called a management service provider or MSP, focuses on providing remote infrastructure management and monitoring (e.g., for LAN, WAN, and desktop functions).
MyCIO.com, for example, provides such an option in addition to its ASP security service, and many customers choose the on-premise alternative. While the MSP model gives up the economies of scale inherent in centralizing hardware, it still can achieve substantial savings (between 50 percent to 70 percent of the functional savings achieved through ASPs) by reducing the need for IT support within adopting companies.
Choose point provider or aggregator model
Small and medium enterprises represent a huge potential market, but the broad reach required for success drives high sales costs. We believe that only a small number of service providers will be able to cost effectively reach mid-sized companies and that, those that do, will need to offer a broad set of services to achieve attractive economics. The Regional Bell Operating Companies (RBOCs) and other service providers focused on mid-sized companies such as Verio, XO, and hosting companies appear well positioned in this aggregator role. Only a few well-capitalized xSPs will be in a similar position.
The majority of other xSPs will likely need to shift from a high-cost retail sales model to instead focus on offering their services wholesale, through the service aggregators. They will need to build network assets, software tools and skills that create sustainable value even without customer ownership.
MSPs: Set to seize the Holy Grail?
Collectively, MSPs captured $120 million in 2000 revenue, compared to ASP revenues of $500 million--but as a group they are growing by more than 120 percent per year. As MSPs make an effective case around feasible models to remotely outsource desktop, LAN, and other infrastructure management functions to companies, this segment will be one of the more promising growth stories. Companies in this space, like InteQ, NCMX, and myCIO.com, may well be onto a good thing.
A final thought on who should be thinking about providing such services; although currently dominated by small start-ups, large outsourcers and hardware providers should also look closely at opportunities in the MSP field. Outsourcers can grow their service lines and offer alternative management options, whereas hardware players can develop value added services for their commoditizing businesses.
Not bad for a segment that seems written off. Long live MSPs!
McKinsey's Shankar Jagannathan contributed to this article.
Paul Roche (paul_roche@mckinsey.com) is a partner in McKinsey & Company's Silicon Valley Office where he has worked extensively in the areas of computer systems, data and telecommunications. Shankar Jagannathan (shankar_jagannathan@mckinsey.com) is an associate in the Charlotte Office where he has worked on several engagements in telecommunications. COMMENTARY--What a difference a year makes. Last year, ASP was the hottest 3-letter acronym. There were niche ASPs, vertical ASPs, and umbrella ASPs. Indeed, it appeared that if you were not an application service provider, you couldn't really be a dot-com.
Fast forward a year, and that picture looks mighty simplistic. Even ASP darlings, like Corio and Critical Path, are struggling. Market analysts are predicting that 60 percent to 80 percent of ASPs could fail in the next year or so. Neither the overall economy nor the mood on Wall Street is helping fledgling ASPs.
Our work with small and mid-sized enterprises, however, reveals that there are elements of the xSP value proposition that resonate with executives, particularly those in mid-sized companies. We believe, however, that a fundamental shift from providing applications to providing management services is needed. A focus on delivery in these areas can help entrepreneurs be successful despite the gloomy environment.
Focus on the economic impact
Mid-sized companies represent the most attractive target segment for network-based services, as they are large enough to require robust infrastructure but typically lack scale to outsource IT functions to traditional system integrators, like IBM or EDS. These companies are also aggressively moving to broadband connections (T1- or DSL-based) that facilitate remote services.
From an economic viewpoint, two dimensions influence the decision to adopt network-based services (vs. implementing internally): 1. Absolute savings garnered through outsourcing. 2. Relative importance of the functionality to the corporation.
The first dimension is the traditionally highlighted measure of the xSP proposition. For example, remote email services may advertise a savings of 65 percent over the cost of using a local exchange-type server.
The second orthogonal dimension captures the overall impact of the savings on the corporate bottom line, as measured by the percent of total IT spending involved in provided the service. Only by combining the two dimensions is it clear which services offer truly compelling economic savings to enterprises.
Despite the focus of many ASPs on business applications, it is surprisingly the oft neglected and less-racy applications, such as desktop and server management, that offer some of the most compelling economic savings. Conversely, the total savings for most companies from seemingly hot areas such as outsourced data storage are small, with exceptions for some very fast-growing or very data-intensive companies.
Solve the mid-size company skill gap
Web hosting highlights the importance of addressing the skill gap. It can lead to significant absolute savings (think of economies of scale with server farms) but overall involves relatively low IT spending for the typical (non dot-com) small or medium business. As a result, the total economic impact of outsourcing is moderate for many mid-sized companies. What is driving the clear trend to adopt fully managed hosting among mid-sized companies? In our discussions, company executives consistently pointed to a lack of critical web management skills.
Many small and medium sized companies have trouble hiring and retaining critical IT staff. This lack of skills is the most important driver of xSP adoption, stronger even than economics. The skill gap is particularly prevalent in areas requiring network- or Web-based technologies. Opportunities therefore abound in areas like LAN management, WAN management, security, Web site setup and maintenance.
Work with company fears of security and control
Both IT and business executives find it difficult to entrust their desktop or corporate application data to a third party due to concerns around security, loss of control, and service reliability. The current market environment and the possibility of losing their data should an ASP fail are exacerbating these fears. While not always rationale, these fears can be difficult to overcome.
Some ASPs as well as new market entrants are addressing these needs directly by allowing companies to maintain their data on-site and, at times, as part of their original application. This new xSP model, typically called a management service provider or MSP, focuses on providing remote infrastructure management and monitoring (e.g., for LAN, WAN, and desktop functions).
MyCIO.com, for example, provides such an option in addition to its ASP security service, and many customers choose the on-premise alternative. While the MSP model gives up the economies of scale inherent in centralizing hardware, it still can achieve substantial savings (between 50 percent to 70 percent of the functional savings achieved through ASPs) by reducing the need for IT support within adopting companies.
Choose point provider or aggregator model
Small and medium enterprises represent a huge potential market, but the broad reach required for success drives high sales costs. We believe that only a small number of service providers will be able to cost effectively reach mid-sized companies and that, those that do, will need to offer a broad set of services to achieve attractive economics. The Regional Bell Operating Companies (RBOCs) and other service providers focused on mid-sized companies such as Verio, XO, and hosting companies appear well positioned in this aggregator role. Only a few well-capitalized xSPs will be in a similar position.
The majority of other xSPs will likely need to shift from a high-cost retail sales model to instead focus on offering their services wholesale, through the service aggregators. They will need to build network assets, software tools and skills that create sustainable value even without customer ownership.
MSPs: Set to seize the Holy Grail?
Collectively, MSPs captured $120 million in 2000 revenue, compared to ASP revenues of $500 million--but as a group they are growing by more than 120 percent per year. As MSPs make an effective case around feasible models to remotely outsource desktop, LAN, and other infrastructure management functions to companies, this segment will be one of the more promising growth stories. Companies in this space, like InteQ, NCMX, and myCIO.com, may well be onto a good thing.
A final thought on who should be thinking about providing such services; although currently dominated by small start-ups, large outsourcers and hardware providers should also look closely at opportunities in the MSP field. Outsourcers can grow their service lines and offer alternative management options, whereas hardware players can develop value added services for their commoditizing businesses.
Not bad for a segment that seems written off. Long live MSPs!
McKinsey's Shankar Jagannathan contributed to this article.
Paul Roche (paul_roche@mckinsey.com) is a partner in McKinsey & Company's Silicon Valley Office where he has worked extensively in the areas of computer systems, data and telecommunications. Shankar Jagannathan (shankar_jagannathan@mckinsey.com) is an associate in the Charlotte Office where he has worked on several engagements in telecommunications.