New world order

"Our company, our entire support organization is undergoing a wholesale transformation," said Tim Chou, president of Oracle.com. "We are changing the economics of the software business."

At Microsoft, "This is about the 'servicification' of all our software," said Sanjay Parthasarathy, vice president of strategy and business development for the .Net program. "It may not all touch the Web or be delivered as a service, but it will all be tied into services that are available any time, anywhere, on any device."

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The two software giants promise that companies will be able to access software and related services on demand. Enterprises will be able to use new applications without installing and tightly integrating them by, in effect, renting - rather than buying - the management skills of a presumably more knowledgeable service provider. How this will ultimately impact price, security, service levels and bandwidth remains to be seen, but the leaders insist it is the future.

Microsoft is trying to leverage its desktop hegemony into leadership in the new era with its .Net services platform. Oracle is pushing managed services for its enterprise suite as a way to cut costs and improve the customer experience.

Although we've been hearing the buzz about software services for more than a year, a close look at what's going on at ground zero at Microsoft and Oracle indicates that software services are much more than just another option the vendors plan to offer down the road: They want to be the gatekeepers of new operating systems for the "supernet" - the interconnected network of networks that will allow enterprises to link every facet of their businesses.

"We're 100 percent convinced that all software will become a service someday," said Jeremy Burton, Oracle's senior vice president of product and services marketing. "Just like water, electricity and every other network, the computer network is maturing to allow that to happen."

Across the industry, the story is much the same as the biggest software companies get down to the serious work of changing the way software is sold, delivered and used by corporate America. IBM and Sun Microsystems have announced their own plans to create service platforms, and major vendors such as Computer Associates International, SAP and Siebel Systems are also increasingly offering hosted services.

"It's the ASP paradox," said Ben Pring, principal analyst at Gartner. "The first-wave companies are struggling, yet everyone seems to buy the idea that this will be a no-brainer." Gartner estimates a $11.6 billion global ASP market in 2004 - less than its previous projection of $25 billion, but up sharply from about $2.1 billion last year.

The key to the paradox is that growth will be driven not by the start-up ASPs - which have gained mind share but not market share - but by the folks that already sell software by the ton. "Look at sales of records by the Sex Pistols as opposed to Nirvana - yet without one you wouldn't have the other," Pring says. "It's going to be the big guys who commercialize it."

In fact, IBM is expected to announce this week that it is formally getting into the ASP business with a hosted and managed offering from Ariba. Until now, IBM has operated a substantial hosting business and has managed applications for clients on a one-off basis. However, with its AribaBuyer application service, IBM will be getting into the business on a large scale.

"We think this could develop into a really big opportunity for us," said Paul Boulay, program director for application hosting service at IBM. "There is a big market of small and midsize companies out there that would like to be able to take advantage of e-procurement, but aren't prepared to make a multimillion-dollar investment."

The potential benefits to customers and the software companies themselves are too big for the vendors to leave services to anyone else. Software as a service promises businesses a new level of interconnectedness and access to a broad spectrum of applications. "The integration possible via services will provide flexibility and speed that will make the CIO's [chief information officer's] life easier," Parthasarathy said. Universal interoperability is an oft-broken promise, though, and not everyone relishes the possibility of another generation of market leadership by Oracle or Microsoft.

Vendors, meanwhile, see a chance to enter new markets, smooth out earnings flow and establish their services as the standards of a new era.

ASPs - or companies such as Electronic Data Systems and IBM that are muscling onto their turf - may prove a viable channel for the delivery of some software services, but hosted application software is only part of the change in how businesses will use software and the Internet.

Microsoft, for example, doesn't mean for all software to be delivered as a hosted service - though it plans to sell plenty that way. Its goal is for all software to be able to instantly access that interconnected service environment on demand.

"It's a misconception that people will get [Microsoft] Office off a Web site," said Dwight Krossa, director of emerging business product management at Microsoft. "What is Office in a software-as-a-service world? A client, a way for people to access some services. The same with Windows. It's an experience you go into."

Said Ian Rogoff, vice president at Microsoft's worldwide partner group: "It doesn't matter if the next-generation business application is hosted or on-premises - software as a service is less an objective than an enabling factor." Southwest Airlines, for example, can use Dollar Rent A Car Systems' reservation software to assemble travel packages on its own Web page, with the disparate back-end systems tied together on a Microsoft platform.

That's what the whole .Net strategy is about: making the functionality of software accessible on demand, and in the process establishing Microsoft as the platform on which it runs best.

".Net is our strategy for embracing an XML [eXtensible Markup Language] Web services architecture for everything we do," said Barry Goffe, group manager for .Net enterprise solutions at Microsoft. "SQL [Structured Query Language] itself isn't going to be shoved out onto the Internet as a Web service, but people who want to build an XML service with a persistent data source on the back will use it as the foundation on which the services are built." .Net also undergirds Microsoft's bCentral small-business applications and its ASP strategy.

Oracle has its own vision for the world of integrated applications.

"We are headed toward a standard e-business platform and infrastructure," Chou said.

But even the enthusiasts admit the ultimate goal of seamless Web services is still years away. "Major technology work needs to be done to get it all tied together," said Chou, who noted that customer awareness, network reliability and bandwidth are near-term challenges.

How long the transition will take is unclear. "I think that a three- to five-year time frame for a financial impact is reasonable, but everything depends on the market uptake," Parthasarathy said. "This has to go through three phases: access, integration and personal relevance. Today, we're in the access phase of hosting software. The next step is a loose federation of Web services, coupled by XML. The key then is relevance to the user. If you are a CIO, you have to think about different audiences, such as employees, partners and customers. HailStorm may be more relevant for end users, Active Directory for employees, and some federation of HailStorm and Active Directory for partners."

There's no guarantee that the specific business plans envisioned by Big Software will pan out. Oracle's strategy depends on customers' buying a suite of software instead of best-of-breed applications, while Microsoft's .Net faces competition from other would-be service platforms, including offerings from IBM and Sun. In addition, a new wave of vertical service providers could take market share away from established companies for some applications. Still, there's no question the software industry is changing for good.

"The biggest problem customers have is integration," Microsoft's Goffe said. "And as bad as solutions like enterprise middleware are inside the company, they completely suck when it comes to doing integration over the Internet.

"Our solution is XML Web services built on a stack of standards," including Simple Object Access Protocol, Web Services Definition Language and Universal Description, Discovery and Integration, he said. "Some standards are still missing, but this will allow people to remotely invoke data and applications as if they were another component locally."

Last week, Gates announced that Visual Studio .Net, a rapid application development (RAD) tool for building Web applications and XML services on the .Net Framework, would ship soon.

Gates also said that due to customer demand, a prerelease version of Microsoft's XML Web services engine, .Net Framework beta 2, will be available for use in production environments. The .Net Framework will be downloadable for Windows 2000 Server products. .Net servers are due early next year.

How customers will gain access to the software remains an open question. "We have no idea how much of our server software will be delivered as a service. We can't say how much revenue will shift when," Microsoft's Krossa said. The goal is to make it ready to support services from any location.

And ASPs may yet turn out to be an important channel. "ASPs are a part of our partnership community," Microsoft's Rogoff said. "The potential is very high, though probably not what we thought two years ago."

Microsoft has spread some cash around the industry, including a $50 million investment in USinternetworking in late 2000. With that investment, Microsoft became the default platform for USi's application services and, perhaps more important, got a front-row seat on the enterprise ASP business.

Microsoft has varying levels of ownership and partnership with numerous other ASPs as well; so far, hosted versions of its Exchange software represent the company's most successful entries into the marketplace. There have been false starts, with some partners asking for Office online in the early days. "They didn't see the huge deployments they expected, because customers already have Office," Krossa said.

ASPs are just one group of partners upon which Microsoft will rely to build its services business. The .Net strategy is largely about getting partners to develop services that run best on the Microsoft platform, much as developers helped seal the dominance of Windows. "It's really about partnerships, not new pieces of software," Krossa said.

That's a sensible path to take, Gartner's Pring said. "The No. 1 thing they have done well over all other companies is work the partner channel," he said. "That's the honey pot around which so many bees buzz."

Partners are also important to Microsoft's new bCentral brand of applications for small businesses. "They're critical - a majority of our sales may come through partners," said Erin Hiraoka, bCentral's director of marketing. BCentral delivers its services via an eponymous portal and at cobranded sites with partners including Compaq Computer; Office Depot, which is also selling the services in its stores; and Rivio. BCentral will use Microsoft's Passport authentication service and other HailStorm services.

A monopoly is a terrible thing to waste, and Microsoft's strength on the desktop is a critical element for bCentral. "Our next phase is closer integration with Office," Hiraoka said. "With about 90 percent penetration in small businesses for Word and Outlook Express, the ability to attach to Office as a key client is huge."

Hiraoka said there are about 60,000 paid users among the 1.6 million registered bCentral users; revenue from ad sales currently outpaces service revenue. About 300 people work under the bCentral rubric, with more than 200 of them building applications. Some services, such as ad buying, are billed as one-time transactions, while a financial management tool, for example, carries a monthly fee based on the number of users.

Accounting applications from Great Plains Software, the services-savvy small-market vendor that Microsoft purchased earlier this year, will be available from bCentral in the future. Again, not everything has to be hosted. "An offline Great Plains product could be an integration point for data," Hiraoka said. "We see a huge opportunity for growth, not just in hosted, but in server-based business applications."

Not everyone is convinced that desktop software will become Microsoft's beachhead for services. And Pring emphasized that Microsoft's dominance in the desktop era is a two-edged sword. "Nobody likes the idea of them being the gatekeeper or Big Brother, somehow managing to become the operating system of the new 'supernet,'" he said.

On the other hand, the network effect and plain old herd instinct could work Microsoft's way. "In the Web services war that's brewing now, it's VHS vs. Betamax all over again," Pring said. "If you choose Microsoft over Sun, it's a 10-year decision, so logically you'd go with Microsoft just because of the safety in numbers.

One area in which Microsoft has some definite market leadership is in software pricing. While most established software companies continue to sell licenses for their products, Microsoft is moving to a subscription model, not just for software delivered as a service, but for the client software as well. "Software as a service includes updates and fixes that may come from the cloud," Rogoff said. ASP customers are also being allowed to pay based on usage.

The shift to service pricing could have a major financial impact on the company. "Their entire mission in life is to annuitize their business and get off the upgrade cycle roller-coaster," said Art Russell, senior technology analyst at Edward Jones in St. Louis. "Historically, they've seen huge spikes in revenue on a new product release, and then it tails off. Smoothing out their business model is good from a financial standpoint."

The company is changing its culture and mentality to become more services-oriented, Oracle's Chou said. "We are moving people from patch-chasers to application managers. The old way is you patch it for each customer, onesy-onesy - nothing wholesale about it, and the cost is astronomical."

Oracle wants companies to use its entire applications suite, modifying their processes to fit its software, rather than vice versa. And it expects the integrated world of the services model to encourage companies to conform. "We build all the software, so we don't spend a lot of time integrating the pieces together," Oracle's Burton said. "If you use online services, it costs you less money."

The trade-off is the lack of user flexibility. "In the hosted world, you can't do everything the customer wants," Burton said. "There have to be constraints, because that is the only way to scale. You've got to minimize the choices, and companies need to change to more standardized business processes."

Will the services suite approach work? Maybe. "Oracle is trying to do what Microsoft did in the productivity market by bundling everything into a suite," Russell said. "Some companies will sacrifice for ease of use and lower cost of ownership, and over time they will make the product better. At the end of the day, people will like having software from a single vendor."

But because some companies want to stick with applications from multiple vendors, Oracle is working both sides of the street. Ellison used to say Oracle applications would be sold by third-party ASPs over his dead body. He relented last year.

"They display a fairly obvious case of schizophrenia," Gartner's Pring said. "Oracle is run by such aggressively commercial people, and at the end of the day, they sell what they can. They will track customer interest and tie in with what works."

Oracle's change of business has been good for Qwest Cybersolutions, a unit of Qwest Communications International and one of the healthier ASPs. "The software vendors used to call all the shots, but now it's different," said QCS CEO John Charters, who has an Oracle engagement that supports 10,000 users at one networking equipment company. "Oracle is bent on allowing us to become a reseller because we built market momentum. Customers aren't going to buy all their software from one vendor."

Still, Chou said third-party ASPs are merely information technology outsourcers, and that only vendors can deliver the true benefits of managed software. "The intellectual property at a software company is its fundamental infrastructure for delivering business processes," he said. "That's how you get the enormous benefits on time and cost."

No matter which company delivers it, Oracle's enterprise software is still priced on a licensed basis, rather than the rental model associated with services. Large companies generally prefer to own software, and Oracle likes to sell big-ticket licenses. And, Oracle argues, the availability of perpetual and limited-term licenses, along with financing options, provides users with the same financial benefits as rental. "Oracle financing is useful as we move into more medium-sized businesses who can afford our applications for the first time because of the lower support costs," Burton said.

The story is different at the small-business end of the market, where Oracle is trying to establish a foothold. Burton said that Oracle's Sales OnLine has 20,000 customers.

The software itself is also changing to be more Web-friendly. "We're making our software easier to use for large and small businesses," Burton said. A hosted procurement and payment service was announced in mid-June, for example, while hosted customer relationship management applications can now be up and running in 90 days. The CRM offering has not yet set the market on fire, Burton admitted. "A number of customers are interested, but we have not begun implementation," he said.

Database services could be provided by Oracle or third-party ASPs, or as part of a specialized vertical offering. Oracle would like to do it all, but the market will decide how the services will actually be delivered. Regardless, a major change for Big Software is under way.

Taking Their Best Shot

In a world where applications are becoming services, the layer of software that supports those services occupies some valuable real estate. Microsoft is trying to leverage its desktop dominance to establish its .Net services platform as a kind of operating system for the new era, but it faces plenty of competition, including platform plays by IBM and Sun Microsystems. And with companies such as Oracle and BEA Systems targeting the Web middleware market as well with their own application servers, the platform wars are still something of a free-for-all.

IBM announced in May that its WebSphere 4.0, due June 30, will support the eXtensible Markup Language; Universal Description, Discovery and Integration; and Web Services Definition Language standards, enabling it to link applications via the Web without extensive integration work. "WebSphere has technology that approaches the breadth of what Microsoft is doing, which is the strength of .Net," said Rob Enderle, a research fellow at Giga Information Group. IBM leads Microsoft in getting products to market, but has encountered compatibility problems with products from its Lotus Development unit.

Sun wants the world to run on Java standards, including the Java 2 Enterprise Edition package of Java technologies embraced by Oracle and other enterprise application vendors, but its Sun Open Net Environment, called Sun ONE, is narrower in scope than .Net or WebSphere. "It's largely a marketing push around the core technologies," Enderle said. "Comparing Sun ONE to IBM and Microsoft is like comparing an engine maker to a car company." Forcing users to buy from multiple vendors to get a complete Web services platform could limit the Sun initiative's appeal, he said.

Analysts said it's too early to pick a winner, but the competitors are trash-talking and posturing the way software companies often carry on when large sums of money are at stake. "IBM talks about WebSphere, but the reality now is the WebSphere logo," said John Magee, senior marketing director for Oracle9i products at Oracle.

Everyone, of course, dogs Microsoft for its proprietary technology, but everyone recognizes that starting out with a grip on the desktop is a powerful opening position.