One hot day last July, US-based application service provider (ASP) Pandesic put out a startling statement: The supposedly solid company announced it was shutting down because it couldn't find "a timely road to profitability due to slower than anticipated market acceptance of business-to-consumer e-commerce solutions."
"It hit me like a cold shower," says Dieter Schoenegger, chief technology officer at Adidas America, a Pandesic customer. "It was really awful. With other dot-coms starting to die, we asked ourselves whether we should just shut the sites down."
The retailer wasn't left disconnected by some small-time ASP. Pandesic was a joint venture backed by Intel and German software firm SAP. The two had committed US$50 million up front and veteran executives from both parents. "These were two dinosaur giants," Schoenegger says. "Nobody expected that they wouldn't last."
Adidas was not alone. Other Pandesic customers, including eHobbies.com, clothier OshKosh B'Gosh, the San Francisco Giants and The Children's Place Retail Stores were all scrambling. Over the past few months, several other ASPs shut down. Red Gorilla, which offered an online time billing and time service ceased operation in October. HotOffice.com, a virtual office services company, shut down in December. So did iSearch, which marketed Web-based recruiting applications. HostLogic closed in early February, leaving customers like Tyco International in the lurch.
Their customers had chosen to employ ASPs because they didn't want the everyday headaches of operating applications. But the ASP carnage left many customers with massive migraines.
Take Ben Young, owner of small Web design firm BigBlueHat. He relied on Red Gorilla for billing clients. One day last fall, "when I was ready to bill my client, the system was gone," Young says. "There was nothing there but a blank white space."
End of the Beginning
This year is what research firm IDC calls "the end of the beginning," when many of the 2,000 or so companies that call themselves ASPs fail. Gartner Group analysts estimate that by year's end, 60 percent of the ASPs that were running in 2000 will have left the race. Other analysts put the failure rate even higher. "I see eight out of 10 companies failing in the first year," says Lew Hollerbach, managing director at Aberdeen Group. "It is the same as the early dynamics in any other industry. But for ASPs, there were unrealistic expectations, and now we're facing a hype hangover."
Despite the hangover, most analysts and customers say the ASP market will emerge stronger. Gartner predicts that the worldwide ASP market will reach more than US$25.3 billion by 2004. The reason: The early appeal of the ASP market still holds. By using ASPs, companies can reduce their labour and capital spending by as much as 30 percent, roll out new apps more quickly and, perhaps most importantly, focus on their core competencies.
"We offer lower, predictable costs and take away the pain of companies trying to manage by themselves," says Mitch Kristofferson, vice president of marketing at Corio. "We can deliver major projects successfully, on time and on budget."
That's what customers want. "We were able to get full-blown e-commerce two to two-and-half years faster than if we'd done it ourselves," says Gordon Craig, director of marketing and e-commerce at Sterngold. The maker of dental products, a subsidiary of London's Cookson Group, tapped Surebridge to deploy a Sterngold Web site that includes frequently asked questions and product, technical and safety information for 4,000 products. "We wanted to be a first-mover within our industry," Craig says. "We didn't want to waste precious time putting something together and losing ground."
Many customers have no desire to learn new skills. "There are very hard barriers to entry for broadband networking, and it is not our expertise," says Mitch Gordon, vice president of business development at LessonLab, provider of professional development applications for teachers. LessonLab uses ASP Connectria to host the Lotus Development Domino platform that runs its applications. "We're education and software development experts, not broadband hosting experts. We need people there 24 by 7 who can provide scalability and bandwidth."
In fact, even those that have been burned by failed ASPs are still looking at the model. "They still have the same issues that they did before: 'Do I have the capabilities to manage the application? Do I have the plans to build this application?' " says Christine Ferrusi Ross, a services analyst at Forrester Research.
In fact, it is very rare that a company that has outsourced an application will take it back in-house, Ross says. "They'll switch providers. They'll say, 'We picked the wrong ASP, but that doesn't mean it was the wrong thing to do.' In fact, I interviewed one customer who kept trashing his ASP, but when I asked him if he plans to do more outsourcing, he said 'Oh yes.' "
Former Pandesic customer Adidas is sticking with the ASP model. "I was still a strong believer in the knowledge and know-how of the ASPs to manage Web infrastructure and components," Schoenegger says. "We wouldn't even suggest building up infrastructure or insourcing ourselves."
But the key for Schoenegger and others is finding the ASP survivors. It isn't easy.
Pandesic told customers it would stick with them through the end of January, helping to bring Web site operations in-house, find another ASP or shut down. After months of trials and tribulations--including an effort by customers to try to keep Pandesic alive--Adidas got lucky.
A group of technology providers--including application infrastructure provider Allegrix; Enterprise Resource Planning software provider Cutsey Business Systems; e-business software service provider Progress Software; and United Parcel Service's warehouse distribution service, UPS Logistics Group--came together to bring up new Web sites in less than four months, with less than US$2 million. The new sites--The store.adidas.com and Teamsoccer.adidas.com--went live 19 January, just two weeks before Pandesic dropped support.
"We beat the high-voltage deadline," Schoenegger says. He had tested the site with live data, and so knew it would work. "But I still kept checking every five minutes in the beginning. And there were no complaints."
The new sites enable Adidas to easily offer a very complex array of styles, colors and sizes in a variety of merchandising scenarios. Customers can order and redeem gift certificates. And most importantly to Schoenegger, there is an automated close-to-real-time inventory update across all elements of Thestore.adidas.com. It is a capability that Schoenegger says was difficult to find. "We don't want customers clicking on a nice picture and finding nothing behind it," he says.
The Children's Place--a US$587 million retailer and another Pandesic customer--wasn't able to find vendors to move as quickly. The company shut down its site in mid-January, and is bringing it back in late April. Like others, The Children's Place is sticking with the ASP model.
Selecting vendors carefully
"Pandesic didn't completely sour us on the ASP business," says Mario Ciampi, senior vice president of store development and logistics at The Children's Place. The company still believes that someone else can do it better than its own information technology (IT) workers. "Clearly, our experience is not in e-commerce," Ciampi says. "It is in the traditional retail chain."
For its new site, The Children's Place has turned to Triversity, a Canadian provider of point-of-sale software that has been working with the retailer's brick-and-mortar business for three years.
"Now we're going back online with someone we have a history with," Ciampi says. "They've got financial capabilities outside of the e-commerce business, and they have a concern in keeping us up." Like others that have been burned by their ASPs, "we've been very, very careful in vendor selection now," he says.
But it's hard to be careful, and last year, when the ASP market was brand new, it was even harder. "There are a lot of posers out there," says Pradeep Khurana, chairman and founder of Surebridge, a full-service ASP for midsized companies.
With the early market rage, any company that could put the letters A-S-P together, got lots of venture funding and press. "They didn't even need to show a lot to get that attention," says Amy Mizoras, an analyst at IDC. But as the market shakes out, ASPs are being forced to prove their mettle, and many enterprises are diligently examining potential ASP partners. "It is just as if they were ready to purchase someone," Mizoras says.
For John Charters, president and CEO of Qwest Cyber.Solutions, that's good news. QCS bills itself as the largest enterprise ASP, and potential customers are usually impressed by the backing of parent company Qwest Communications International.
"QCS has very deep financial pockets, and a very big commitment from Qwest," says Joe Bologna, director of IT infrastructure and services at Expanets. A provider of networked communications solutions to midsized businesses, Expanets just awarded a five-year, US$22 million contract to QCS. "We were only looking for cream-of-the-crop companies," he says.
QCS has built up its strength by seeking out larger, established customers, not start-up, pre-IPO companies. "Now, we're glad we don't have 20 [percent] to 40 percent of our revenue as bad debt from companies that are no longer in a growth market," Charters says.
Other ASPs, such as 2-year-old Corio, are moving away from a focus on the dot-com start-up market. Early on, Corio had targeted the dot-com space, snagging such names as Excite@Home, Lycos and MadeToOrder.com. Now Corio, which is backed by Microsoft, PeopleSoft and Sun Microsystems, has changed its ways.
"For us, the biggest challenge has been the disappearance of the dot-com companies that fuelled our early growth," Corio's Kristofferson says. "Now, midsize brick-and-mortar companies and large enterprises are becoming our customer base." In fact, half of Corio's customers fit into that category. "ASPs just riding the dot-com wave are running into trouble," he says.
Corio appears able to move forward without seeking additional funding. Although it had a fourth-quarter net loss of US$19 million, Corio reported revenue of US$14.1 million, quintuple its revenue in the fourth quarter a year earlier. Revenue from application management services--the aggregate of the recurring monthly hosting fees, in which Corio sees the greatest opportunity--were US$6.8 million, up 57 percent from the previous quarter.
USinternetworking--though it gathered US$300 million in new funding, including a US$50 million equity stake from Microsoft, during the last quarter of 2000--hasn't done as well, but is working to shore up it strength. The company recently convinced AT&T to sell USi services to large enterprise customers. USi is trying to ink deals with other large telecom players as well.
Another ASP, eOnline, is going after large enterprises with the help of major consulting firms like Andersen and Grant Thornton, and more than 20 others. Those alliances have produced 70 percent of the company's business leads.
Jamcracker, the ASP headed by Exodus Communications co-founder K.B. Chandrasekhar, has an alliance with Accenture. The company has landed US$142 million in venture funding and more than 50 customers since its launch in February 1999.
How to Pick
But to pick ASP survivors, enterprises need to look beyond financials. Forrester's Ross recommends that customers start by checking out the application offerings and determining their own need for customisation and reliability.
When customers have assessed their customisation needs, they can decide whether to find a provider that can cheaply offer vanilla applications--such as email--or one that can develop custom fields for SAP. The former will look to make its money on volume, while those that customise will look to make margins on services. "If you don't need customisation, then you go for the best price," Ross says. "If you need customisation, you don't want to trade cost for functionality."
When examining an ASP's customisation capability, Adidas' Schoenegger recommends being sure the vendor can perform with tests based on live data. "Be careful to ensure what they promise is what the reality is. I wouldn't trust anyone who can't provide a prototype I don't have to pay for," he says.
Customers then need to consider how important reliability is to the site and what they're willing to pay for, Ross says. "Decide what it means if the application goes down for an hour or five hours. If I'm Amazon[.com], being down for an hour is unacceptable. If I'm The Children's Place, it hurts me, but I can keep the business running," she says.
A strong service-level agreement includes measurement, management, reports and penalties, explains Warren Wilson, practice director at Summit Strategies. The SLA should cover infrastructure to the people who will be accessing the application. Customers need to be able to measure service metrics. As customers negotiate SLAs, they should be sure to ask for the SLA performance histories of the ASPs.
Of course, not everybody has the same theory on SLAs. Don Jennings, vice president of information services at MadeToOrder, believes that a very strict contract may lack needed flexibility. "If your contract says you need it in four days, and then you need it in one, what happens to your contract?" Jennings says. In his contract with Corio, Jennings has built in the option to sit down once per quarter to discuss more than 400 service-related issues.
A customer should also be sure it has the ability to get out of the contract if the ASP isn't performing. DaimlerChrysler Capital Services recently hired QCS to run its Service Access Point financial applications. Instead of focusing on SLAs, the company made sure it has the ability to walk away from the contract if it is unhappy with the service. So far, that isn't happening. DaimlerChrysler recently extended the deal to five years from the original three and bumped its user count from 50 people to 100. Now the auto group, which manages an US$8.5 billion portfolio and has about 500 employees around the world, is evaluating ASPs in hopes of outsourcing human resources applications from PeopleSoft.
Another thing to examine is the industry certifications that ASPs are starting to attain. ManagedOps.com, QCS and USi have been named by Microsoft as Gold Certified Partners for Hosting and Applications in the US. They all met the eligibility, service quality and operational readiness criteria of the Microsoft Gold Certified Partner Program. They had to demonstrate the capacity to deploy and scale Microsoft technology across different product offerings with high levels of service readiness and competency.
In addition, QCS recently announced that it is the first ASP to successfully achieve the SAS 70 Type II certification, developed by the American Institute of Certified Public Accountants. The certification endorses the company's internal control structure. The SAS 70 certification, performed by Andersen, evaluated QCS' complete managed services environment, including its transition and activation procedures, security, helpdesk, problem change management process, monitoring systems, operations, disaster recovery program and other elements.
Once the contract is in place, customers need to stay tight with their ASPs. "Customers need to take ownership of their projects and realise that this is a partnership," QCS' Charters says.
Corio's Kristofferson agrees. "There was an initial impression that ASPs replace staff. If you're a large company with tens or hundreds of IT projects, an ASP will complement that. That understanding took a while," he says.
The reality is that a company can easily end up like the customers of Pandesic, Red Gorilla or even today's strongest player. "You are at the mercy of the company when it comes to the service they provide," BigBlueHat's Young says. He turned to paper-based billing after the Red Gorilla outage.