The Value Proposition: The Economics of Application Service Provision

Paul Strassmann, leading technology guru and Butler Group associate, believes Knowledge Capital is the true currency running the corporate world. Jonathan Stephenson, Butler's UK expert on Strassmann's work, looks at ways to measure the value of knowledge...

Paul Strassmann, leading technology guru and Butler Group associate, believes Knowledge Capital is the true currency running the corporate world. Jonathan Stephenson, Butler's UK expert on Strassmann's work, looks at ways to measure the value of knowledge...

Application service provision (ASP) is fast becoming the most talked about development to come out of the internet computing model. In an age of skill shortages and escalating IT support costs a solution that gives management the whip hand, removing the power and control of IT from technocrats, will attract the attention of the senior manager looking for a way to cut the cost of information management. However, like so many of the internet technology silver bullets, there are precious few economic models available to assess the benefits. ASP is at the 'early adopter' stage in Europe and as usual for this type of development, estimates for the potential market size are wildly scattered. Estimates of the current and future size of the ASP market vary from around $1bn to ten times that in five years time. No wonder so many companies are re-positioning themselves to get a slice of the pie. The ASP arena is filled with international telecommunication trunk providers, software and hardware manufacturers, ISPs, outsourcing specialists and integrators. In the short term there is a window of opportunity for the smaller pioneers. But in the long term who will gain and loose from the shift from a product oriented industry to a service model? Giants such as Microsoft make good money from software sales to end-users. Upgrades and maintenance form a significant slice of their profits. In the ASP model the software will be licensed on a rather different model but essentially the software still has to be licensed and upgraded. One ASP provider renting out the services of a software package to 10,000 end-users will spend a good deal less than 10,000 software users in separate organisations. Hence Microsoft's interest in the ASP market. You can assume that all the main players in the industry will be investing in the ASP market to ensure a share of the potential profits. The smaller ASP niche players who are pioneering the market today will find themselves competing unfairly against the big names who will enjoy advantageous licensing deals and 'special relationships' with the likes of IBM, Microsoft, Oracle, SAP, and Sun. For the firms looking at ASP as a solution to their IT requirements there are many potential advantages. For starters there is the awful track record of the DIY software development approach. Surveys of IT projects have shown that over 40 per cent are cancelled, 28 per cent are over budget or late and a paltry 26 per cent complete on time, on budget and to specification. This represents $100bn of wasted effort and lost opportunities. The build and junk cycle that took us from mainframe to mini to PC client/server and now to internet has been an escalating expense that will probably reach a global total of over a trillion dollars before we complete the current cycle. The established IT model of software purchase, configure, deploy, upgrade, maintain and support represents not only a high level of expenditure but also a lack of flexibility that works against a company competing in a volatile marketplace. If you track the costs of this approach, adding up the cumulative expense of the lifecycle and compare with the actual value of the software assets then a disparity becomes clear which will only increase with time, diminishing the notion of 'value for money' that drove the initial purchase. The 69 per cent of your IT budget that is the upgrade, maintenance and life-cycle support costs is effectively the asset rot that your customers have to pay for in the inflated cost of goods. In the ASP model you pay for software services on a per user, per month basis. Upgrades and maintenance costs are not your problem. If you rent office productivity or mail applications in this way you are talking about perhaps £20 per month per user. The communications costs of shipping all the data and user interface traffic from your LAN to the ASP server farm may be part of the deal or not! Your ability to respond to changes in demand for IT by adding a few more users or removing some without incurring licensing costs is an obvious benefit. You are free to move to another software package if it suits your needs better, change ASP provider or completely redesign your business without incurring the usual re-engineering costs of software development. So, the economics of the case are predominately in favour of the 'rent it, don't build it or buy it' model. The technical case is less clear when you look at real software systems. Most of the financial services industry in the UK is built on legacy COBOL systems that can't be replaced or easily integrated into the ASP model. Many large banks, insurance companies and similar service industries have already outsourced their PC desktop applications and may not find the ASP approach has as much to offer. For many organisations the issues of application integration may offer obstacles and the relatively narrow selection of applications on offer in Europe at the current time will mean that for many the best strategy is 'wait and see'. For the smaller companies who are growing fast the benefits are enormous and the increasing amount of fibre networks being laid by the international telecoms companies will make ASP an attractive alternative to DIY IT. Just as today companies are renting their company cars, PCs, laptops and servers it is only a matter of time before software is paid for on the same basis.