Dot-com bust hits Web hosting biz hard

At the peak of the Web's growth, the building boom extended beyond the virtual world into actual real estate, as Exodus Communications, GlobalCenter, Digital Island, WorldCom and many more built high-tech hosting facilities around the world trying to keep up with demand for Web server space.

Like the boom in glass-and-steel loft residences in San Francisco's warehouse district, for a few years it appeared that hosting companies couldn't overbuild. Even with a rush into the market by telecommunications companies, start-ups and giants such as Intel, companies were selling space as fast as they could build it.

But that phenomenon has come to a crashing halt, forcing the data center companies into crisis mode. Exodus, the leading independent company, was the latest to announce cutbacks, saying Wednesday that it will lay off 15 percent of its work force.

Others, including Digital Island and Intel Online Services, the chip giant's Web hosting unit, have scaled back construction and shuffled workers away from their hosting services.

"What you're seeing is an about-face in supply and demand," said Carrie Lewis, an analyst with The Yankee Group, a market research firm. "All these data center plans were made (last year) and at that point everyone saw demand going up. Then demand fell off a cliff."

The woes of Exodus, Digital Island and others are endemic in the Internet infrastructure business. Networking companies are finding they can't keep up with the debt incurred to build networks, with companies like Cisco Systems seeing demand drop through the floor and new services companies such as Marc Andreessen's Loudcloud finding that cash to build expensive new businesses is running short.

On the hosting side, companies have seen many of their dot-com customers dissolve. But even the larger companies have cut new spending to almost nothing in recent quarters as they try to determine what amount of spending on the Internet is justified.

In a conference call with analysts last week, Digital Island Chief Executive Ruann Ernst said her existing and potential customers had shown a "deer-in-the-headlights reaction" to new spending this year. However, some signs of recovery started appearing late in March as some large companies "started making decisions again," she added.

Whatever glimmers of light Ernst is seeing, it's clear that the data center companies are quickly rethinking their expansion plans.

Analysts say demand will pick up again as the economic pendulum swings back, perhaps following the classic boom-and-bust cycle of real estate prices. But for now the numbers show that the building binge in recent years wasn't justified.

Digital Island reported last week that use of its data centers will be at only 44 percent for the second quarter of this year. It's delaying the opening of its Dallas installation and construction in New York. Exodus has said it is slashing its capital expenditure budget this year and will wind up with about 17 percent less data center space by the end of the year than it originally projected.

Amplifying the effect is the progress of server technology that has slimmed down the physical boxes needed to host Web sites, allowing companies like Exodus to pack considerably more equipment in a given space.

Analysts say they are confident that the strongest companies will emerge on the other end of the bust in fairly good positions, however. The overall demand for Web hosting services will not go away, and most of the companies are beginning to grow beyond the basic space-renting business to more complicated Web site management services.

Qwest Communications International was the latest to move along this path, announcing a new set of hands-on services Wednesday.

The drop in demand is also prompting a more efficient use of facilities, insiders say.

One former hosting industry executive who asked not to be named said that in years past, the industry was too quick to build data centers and co-location facilities in most major cities. Experience is beginning to prove that having a handful of larger, more central data centers is more efficient.

"They're going to bigger, fatter centers," the former executive said. "That's where some of the layoffs are coming from."

But analysts say demand will eventually catch up with last year's building boom. "It's not all gloom and doom," The Yankee Group's Lewis said. "The Web hosting marketplace is viable. They just have to reassess and refocus. That's a good thing."

News.com's Corey Grice contributed to this report.