Land of opportunity for hosting service providers

What's happening in the hosting service provider industry today, and where will the opportunities be once the dust settles?

One thing is sure: The hosting industry survived the dotcom shakeout, but it wasn't pretty. Turmoil and consolidation rattled the industry for 18 months. And it isn't over. Providers continue to announce plans to restructure, to sell their assets, or to file for bankruptcy.

At the same time, increasing numbers of businesses--small, medium, and large--are using hosting service providers for some or all of their IT needs. In these difficult economic times, using hosting services has the distinct advantage of avoiding the potentially enormous capital demands of building an e-business infrastructure.

Providers that make it through the next round of consolidation and figure out how to maximize their efficiency and direct their resources toward a targeted audience will be poised for an impressively lucrative opportunity as the demand for hosting services continues to rise.

Hosting service provider segmentation--The consolidating landscape

The range of providers offering hosting services is as broad as the services being offered. Some providers offer storage and nothing else; some offer little more than basic connectivity, floor space and power; others provide a full array of sophisticated services. While the range of services being offered is broad, the field of providers is narrowing.

Infonetics Research divides hosting service providers into 4 groups: Tier 1, Tier 2, Hosting-Only, and Storage Service Providers. The majority of consolidation has occurred within the Hosting-Only and Storage Service Providers segments, but Tier 1 and Tier 2 providers are not immune from this continuing force in the industry.

North American Hosting Service Provider Types
	Customers	Range of Services	Relationships
Tier 1	Broad customer focus and captive customer base	Wide range of services, including hosting	With hosting-only service providers to expand their capacity
Tier 2	Broad customer focus and captive customer base	Multiple services, including hosting	With Tier 1 providers for optical backbone connectivity
Hosting-only	Focus on large organizations, with a regional or national focus	Focus on hosting	With Tier 1 and 2 providers for co-location space
Storage	Broad customer focus, customer base determined through Tier 1 and 2 partnerships	Storage only	Use Tier 1 and Tier 2 service providers as a channel to their target customers

Tier 1 service providers

Tier 1 service providers comprise the IXCs (e.g., AT&T, Sprint), the RBOCs (BellSouth, Verizon), the remaining large CLECs (WilTel, Level 3), and the regional phone companies. They are mostly long-standing, giant companies that offer a wide range of services, hosting among them. All have built their own data centers--usually situated near their own optical backbones--with which they connect their data centers to the world. They have a broad customer focus and a captive customer base in terms of marketing their hosting services along with other services offered.

Many of them bought stand-alone hosting service providers during the white sale, and hosting has become a large part of their business. They maintain relationships with hosting-only service providers as a way to expand their own hosting capacity without building new data centers.

The recent events surrounding WorldCom's Chapter 11 protection filing calls into question the viability of even Tier 1 service providers, but nonetheless this segment continues to hold the largest opportunity for vendors of networking equipment.

Tier 2 service providers

The Tier 2 service providers comprise the smaller phone companies, the IOCs, and the large ISPs that don't own their own optical backbone, relying instead on backbone technologies such as ATM or a Tier 1 backbone. They are similar to their Tier 1 cousins in everything except the scale at which they operate. They have fewer data centers and are less likely to have any of them located outside the U.S. and Canada. The Tier 2 service providers also have a broad customer focus and a captive customer base to market multiple services, including hosting.

Some Tier 2 service providers also bought stand-alone hosting providers when the buying was good.

Hosting-only service providers

Hosting-only providers have not evolved a backbone; instead they are often co-located with the big carriers, or they have bought a big pipe to them. Most have focused on large business customers, not wanting to spend the dollars required for marketing to medium or small businesses.

Most hosting-only providers were bought up by the Tier 1 and 2 service providers when their dotcom customer base imploded. The ones remaining are generally national or regional in scope and stand to benefit from the consolidation--buying the assets of ailing competitors and positioning themselves to meet demand as growth resumes in the hosting market.

Storage service providers

The infrastructure required for storage is different from that for a true data center, and storage-only providers focus on outsourced storage, usually renting space within other service provider facilities and using that hosting provider as a channel to their customer base. Some of the largest hosting service providers may have 2 or 3 storage providers using their data centers. There continues to be consolidation within this segment, as exemplified by Cable & Wireless's purchase of selected assets of StorageWay.

The end-user opportunity for hosting service providers

Managed hosting represents the most lucrative opportunity to hosting providers, but demand for both managed and unmanaged services is growing significantly. In our study User Plans for E-Business Infrastructure and Hosting, U.S./Canada 2002, we forecast that worldwide end-user expenditures for managed hosting services will grow 443%, from $1.4 billion to $7.6 billion between 2002 and 2006, and expenditures for unmanaged services will grow 133%. Combined, managed and unmanaged expenditures will grow 247%, from $3.6 billion to $12.5 billion. Most hosting providers are eyeing managed services for the future because they appeal to organizations of all sizes, are high-margin, and create customer loyalty. End-users are moving toward managed services because of continuing difficulties in hiring, training, and managing the staff required to support all business applications on the network.

Conclusion

The past year and a half has seen tremendous turmoil and consolidation among hosting service providers. And the trend continues: On Nov. 4, VitalStream announced the acquisition of some Epoch Hosting assets. On Nov. 11, Digex announced that it is exploring strategic alternatives, including the possible sale of the company. And on Nov. 13, Cable & Wireless announced a major restructuring of its global activities, including reducing their hosting data center facilities globally from 42 to 23 over the next 12 months.

Meanwhile, customer demand for hosting services continues to grow. Organizations of all sizes in North America are looking for hosting services to keep their business applications up and running smoothly. Providers that survive the consolidation with increased focus and efficiency will be well positioned to meet this continuing steady demand for hosting services.

Neil Osipuk is Directing Analyst of Data Centers and Hosting for Infonetics Research. He can be reached at Neil@infonetics.com.