THE PIE-EYED PIPERS OF VPN

Funny story: When software vendors don't want to talk about who their competitors are, they have this script, which every once in a while turns out to be true. It reads like this: “Our greatest competition comes from our customers' own internal IT department.”

Service providers are saying the same thing as they scrap for the managed network services market. For them, the script is true. There already is an imbalance between the money spent on IP-based virtual private networks (IP-VPNs) and the percentage going into carrier coffers, according to a study by IDC. Of the $9.1 billion spent last year on IP-VPNs, only $2.2 billion was spent on carrier-managed services. That's a paltry 24.2%.

So who's getting the rest? Some 75.8%, or $6.86 billion, spent on IP-VPNs last year was on do-it-yourselfers, or DIYs. DIYs are the gutsy, self-reliant corporate networking experts who feel they can manage networks just fine on their own.

IDC expects the IP-VPN market to grow to $13.4 billion over the next four years. There could hardly be a more natural fit between a market and its suppliers than the one made ready-to-wear by the demand for VPNs and the capabilities of the world's best network managers — the carriers. Or could there?

Despite recent claims by all the major carriers that managed services are one of their top priorities, IDC sees the trend toward DIYs growing, accounting for $10.3 billion of that $13.4 billion. “Some analysts still predict a shift toward carrier-managed VPN services, but we've changed our tune,” said Steven Harris, research manager at IDC. “We think it's going to go the other way.”

There is still time for carriers to turn the tide in their favor. They are convinced that they can. But with only three percentage points separating the market share of the top four IP-VPN providers in the U.S., it is difficult to say if there will be any big winners or who those winners will be.

IDC's Harris said the current market leader for managed IP-VPNs in the U.S. today is AT&T, with 7.7% of the market. WorldCom is next with 6.7%, followed by Savvis (5.9%), Sprint (4.9%) and Genuity (4.5%). Qwest Communications, Equant and XO Communications range from 2.8% to 1% respectively, and Infonet and SBC Communications come in at just under 1%. And it could be that the big winners have not yet made the charts.

Globally, the rankings would be quite different, Harris said, with Cable & Wireless and Equant climbing the ranks (Equant ranked highest among eight enterprise network service providers in Europe, according to a Yankee Group study released last month). There also are relative newcomers such as Denver-based Virtela Communications and ClearPath Networks that focus entirely on the VPN market and could emerge as dark horse leaders of managed IP-VPNs.

The winners may be decided as much by which markets carriers neglect to target as those they include. Current market leaders are exploiting their global reach to attract the top-tier customers. However, these customers may be most prone to self-management, and without the management of services layered on top of the IP-VPN, it becomes just another commoditized, low-margin pipe.

Cable & Wireless is going after the global market using facilities that were once part of the Concert network to reach customers all over the globe.

“You have to play to your strength, and our strength is in meeting the needs of companies with international requirements,” said David Lowe, director of product management for IP network solutions at C&W. C&W knows that reach won't be enough to compete against other global players, so it is playing up its other strength as well. The company is bundling hosted business applications through the acquired holdings of Digital Island and Exodus Communications to add value to its network services. C&W bought the struggling application service providers in May 2001 and February 2002, respectively.

“Other vendors have networks that may be more broad than ours in terms of network [points of presence,] but their capabilities around these POPs are pretty thin,” Lowe said.

Provided the company's current strategy survives the scrutiny of its newly appointed leadership — it named Francesco Caio as its new CEO and Kevin Loosemore as its new COO on April 3 — C&W could be among the winners in the global IP-VPN market.

Virtela also hopes to play on the global stage. “The VPN value proposition makes a lot more sense for customers with international locations,” said Maaz Sheikh, vice president of product marketing. The 3-year-old Virtela, which got an additional $11 million in funding last month, is counting on several factors to get its name on the IP-VPN leaderboard. One, on which most competitors also are counting, is traditional carriers' reluctance to cannibalize their own revenue streams from frame relay, ATM and other private line services by aggressively selling IP-VPN.

“It is a complete change in philosophy for companies that are used to selling dumb pipes to start talking about managing services for the enterprise,” Sheikh said. “They are making millions of dollars off their private lines. They are very high-margin and that is what Wall Street is pushing them to deliver on.”

He said he agrees with IDC's assessment that new niche providers will eventually dominate the managed IP-VPN market, primarily because his company is one of them and for the reasons mentioned above, but also because companies like his are generally facilities-agnostic and offer enterprises more options in terms of routing and local access.

Virtela contracts with several backbone providers (which double as competitors) including AT&T, Sprint, WorldCom and Qwest. It also uses the facilities of Colorado neighbor Level 3 Communications. One of Virtela's competitive advantages, Sheikh said, is its ability to route intelligently over these networks based on real-time performance. It gives end users the routing flexibility of the Internet with the security of the best Layer 2 backbones in the world, Sheikh added.

Where Sheikh sees competitive differentiation, his competitors see a management nightmare. Even he admitted that there are drawbacks to managing more than 100 carriers and backbone providers, but he said his company has turned that into its advantage.

“Managing the different carriers is complex. That's why we concentrate only on IP-VPNs,” Sheikh said. “Our network management systems were built with this in mind. We don't have to support calling cards and long-distance billing.”

While Virtela is using the reach of its backbone providers to target global customers, it is nonetheless going after the mid-market and niche opportunities within Fortune 100s. “We don't expect to take over their entire corporate networks anytime soon,” Sheikh said. “But these are applications that the carrier simply cannot do.”

True or not, they are going to have to try. Mid-market opportunities could be where traditional carriers will succeed or fail. “Most large carriers have been focused on the top end of the market, which is a very logical place to start, but we think the big push for carriers is going to be down market,” IDC's Harris said.

OVERALL DOLLAR VALUE OF U.S. MARKET

Total market for IP VPN…

...in 2002 was $9.1 billion; in 2007 it will grow to $13.4 billion

Market value for DIYs was $6.86 billion in 2002; Grows to $10.3 billion in 2007

The market for carrier-managed services in 2002 was $2.25 billion; will grow to $3.1 billion in 2007

Source: IDC

Cannibalizing their own services may not be as distasteful for carriers as their competition thinks. Cathy Coughlin, president of business communication services for SBC, said while trumpeting the RBOC's managed services platform called PremierSERV last month, “You can eat your own or someone else is going to. We can't be afraid of evolution.”

SBC is making no bones about going after the smaller markets. “We have played at the high end of the market for a long time, but now with long-distance relief… we see an opportunity to move into the mid-market,” said John Regan, vice president of marketing for managed network services at SBC.

What's important about SBC's strategy — as well as BellSouth's, Verizon's and soon-to-be Qwest's — is the emphasis on managed services, not just network services. SBC specifically has singled out the DIY market and says it is going to aggressively pursue it.

That's really a smart move, IDC's Harris said. “Carriers have been focused on their direct competitors, meaning other carriers, but their biggest competitor is the internal IT departments at each company.”

SBC's PremierSERV strategy encompasses a wide range of managed services including IP-VPN, which will transform the company's approach to the medium-sized business market on a national scale, thanks in part to the aforementioned long-distance relief. In doing so, the service provider will inevitably butt heads with other carriers. “It will be logical that we will run into each other as we follow our customers wherever they go,” Coughlin said.

SBC will run into BellSouth, which launched its managed IP-VPN service late last month after giving up on its struggling hosting business. It will run into Verizon, whose long-distance relief has come much quicker and more broadly than SBC's (Verizon claimed in January to have become the nation's third largest long-distance provider.) And it will run into companies such as ClearPath, a single-minded supplier of managed IP-VPNs.

El Segundo, Calif.-based ClearPath is the reincarnation of a company called InternetConnect, which was founded in 1996 by Cliff Young, now CEO at ClearPath. InternetConnect developed an MPLS-based VPN service in 1999, but it was eventually sold to Covad Communications after the dot-com meltdown quashed its bid to go public.

ClearPath is now targeting what Young calls the business community's most underserved market: small to medium-sized companies. “The key is to give them a turnkey solution that provides everything they need to leverage the network, and nobody has been able to do that for them — until now.”

Three things help ClearPath stand out in this segment: Level 3 supplies its backbone; it built and offers an iNOC interface that allows it to manage any type of network; and it is focused primarily on MPLS technology.

“That's what we are best at,” Young said. “We are as good as anybody else on IPsec VPNs, but an IPsec VPN is an IPsec VPN; it runs over the public Internet.”

Young also subscribes to the anti-cannibalism theory that for now leaves the door open for companies like his to grab market share, particularly in the segment he and others believe the carriers will address last, if at all. But like the carriers, ClearPath will have to convince the DIYs that outsourcing is in their best interest.

The telecom bust put a lot of networking talent out on the street, and small companies can turn to these people to manage their own networks. But Young said financial concerns for small companies are the same as for big ones these days. “The businesses we talk to are still under a lot of pressure to reduce costs, and it is cheaper and probably always will be for small businesses to outsource this type of thing,” Young said.

ClearPath's iNOC portal gives small customers something they may not be used to with their network provider: visibility into network performance. They can monitor network status, view bandwidth usage and availability, manage passwords and user names, submit trouble tickets and update user profiles, account billing and contact information — all the while leaving the running of routers, servers and other equipment to ClearPath.

The question for carriers is whether they can do the same for tens of thousands of enterprises while also continuing to deliver on their core services. As enterprise users get more sophisticated in demystifying network technology — thanks in part to more user-friendly management systems — the question for all managed service providers is: Can you overcome the self-reliant spirit of the American entrepreneur and convince enterprises that, if they want something done right, they should not do it themselves?