Kicking ASP

As one of the first to make a pure play in the nascent application service provider market, USinternetworking has a dull name but a hot business model.

True story about Christopher McCleary, president and CEO of USinternetworking: A month after founding the company, with no staff and headquarters in his lawyer's office, he sent a letter to then-president of PSINet, Peter Willis, offering to buy the company.

"That was a long time ago, back in early January '98, when I was ramping up," McCleary recalls. "I saw that PSINet was extremely undervalued. So I put together an investment group to possibly acquire it, sell the connectivity business to a [competitive local exchange carrier] and use the Web hosting platform as the base to launch USi. It was rejected, but they made some changes based on that experience that have benefited their shareholders. They became more marketing-oriented, which was my biggest complaint."

No one can make the same complaint about either McCleary or his company, generally considered to be the first pure play in the white-hot application service provider (ASP) market.

A former chairman and CEO of Digex, McCleary shepherded that Internet company to a 1997 buyout by Florida telco Intermedia, then handed over the keys and looked for something else to do.

By examining case studies of networked applications - including some Digex clients - he detected a systemic problem with the way those applications were being delivered, to wit, the responsibility gap between the applications and the hardware, operations and communications layers that enabled them.

McCleary's idea was that a lot of mid-market companies wanted to get in on the Internet bonanza - selling over the Web and running back-office functions from a desktop PC - but didn't have the time to assemble the tools and recruit the IT talent. McCleary's notion: Buy and install the software to manage sales forces, human resource programs, supply chains and Web stores from high-profile application partners such as PeopleSoft, BroadVision and Siebel Systems; keep the programs at USi's own data centers; and let clients pay monthly fees to access the applications over the Internet.

Smells like paradigm shift

It's an idea that strikes many analysts as sensible. "People have compared the software market today to the hardware market 25 years ago," says Edward Lovingood with Telus Strategies. "Back then, companies first began realizing that they didn't have to rent time on a remote mainframe computer; they could bring computing inside the office with desktop PCs. Now, those same desktops are the key to moving software out of the office."

And it's also a hit with other providers. USi was almost alone when it started up about two years ago, but industry estimates put the number at about 100 ASPs today. And although total revenues for the ASP industry are pegged at only about $150 million in 1999, those numbers will hit $2 billion by 2003, according to Clare Gillian, an analyst for International Data Corp.

As you'd expect of an industry that touches so many trends - outsourcing, the digital corporation, the e-commerce boom - and generates such high-flown projections, the ASP industry today is a mongrel, with new entrants coming in from all corners. Aside from a few pure plays, such as USi, there are facilities-based carriers that also provide voice and Internet connectivity a la GTE Internetworking and Qwest Communications (see sidebar on this page).

Systems integrators, ISPs, telcos and computer manufacturers are potential competitors for rent-an-app dollars. Hardware maker Sun Microsystems announced last September that its new software purchase, StarOffice, would move productivity applications over the Web.

Last November, Oracle became the first large software company to create its own ASP, Oracle Business Online, complete with a $100 million venture capital fund for ASPs that employ Oracle technology. Microsoft, too, has made feints in the direction of renting its applications over the Internet.

One sign of the maturation of software over the Web is its fragmentation into categories. ASPs license software systems written by outside developers and rent them, usually to a broad range of business clients. This is the way of USi, GTE Internetworking and Qwest Cyber.Solutions. Business service providers usually develop their own applications and target a narrow industry - such as Tibersoft, which rents food service supply chain software. And computer service providers run data centers that act as server farms and distribution channels for the first two categories - such as Exodus Communications, which hosts both Tibersoft and ASP Corio (see sidebar on this page).

Double vision

What gives USi an edge, McCleary says, is its drive to excel both as a networker and as a solution integrator. "To design, build, operate and scale best-of-class, telecom-driven data centers and to implement, support and scale packaged apps from best-of-breed suppliers - these are our `co-primary core competencies,'" he says. "Until now, anybody that's attempted this has not really given them equal priority."

The dual focus is important because, increasingly, the value of an application these days is inextricable from the communications system that delivers it. Without interconnection, a sales force automation app such as the one provided by Siebel is no better than a calendar and a Rolodex.

"The boundary between applications and communications is getting very blurry - just an artifact of the fact that these two industries grew up separately," says Andrew Stern, chief operating officer for USi. "The value of these functions comes from the integration between the application and communications layers. And it makes sense to have a single vendor responsible for both."

On the network side, USi practices what it calls PriorityPeering - avoiding network access points in favor of direct links with 12 of the top Tier 1 global Internet backbones. Users don't have to hop from one backbone to another; 90% of them can stay on the same link all the way from their location to USi's data centers, says Kurt Gastrock, vice president of engineering for USi.

Those relationships are contractual, McCleary emphasizes, and mean priority service from the backbone provider with service level agreements covering availability and response time. "When I was at Digex, we had a terrible problem with one of the major [interexchange carriers] in our peering agreements, and they got to fixing it when they wanted because it wasn't a client trouble ticket," he says. "I want to be able to call John Sidgmore [vice chairman of MCI WorldCom] at home when I'm having trouble because we're a customer, by God."

Two things mitigate the higher cost of this architecture. U S West has a 10% equity stake in USi and the right to market the company's services in its territory. In return, USi got funding and the right to buy its bandwidth through U S West, usually at a 40% discount. Second, because it provides so many other services, bandwidth is only 10% of USi's recurring monthly cost.

So premium bandwidth is part of USi's business model. "We want clients to treat the Web like the telephone," says Jeffery McKnight, executive vice president for operations and client services for USi. "If dial tone seems to come from God, we want Web tone to come from God, too."

Those 12 backbones are wired into each of USi's four data centers by T-1 and T-3 links. If an ISP or a link goes down, traffic is routed through another backbone. Customer data is mirrored in at least one other data center with daily incremental backups and weekly full ones.

And because the Internet is not always the appropriate medium for very confidential communications, USi also offers end users the option of connecting to its data centers via USi-Link - the closed virtual circuit capability of frame relay and ATM. This is most likely used for an application such as core financial data, where security needs are high and the need for remote access is low.

"We're not necessarily zealots of the public Internet so much as of whatever communications layer makes the best sense for the application," McCleary says.

The applications run on servers linked to meshed routers in four data centers: two primary ones in Annapolis, Md., and Milpitas, Calif., and two secondary distribution sites in Amsterdam, Netherlands, and Tokyo that currently handle global distribution for U.S. clients (Figure 1). USi expects to upgrade those to primary sites as it expands in Europe and Asia.

The company manages its data centers and its customers' networks out of a global enterprise management center in its Annapolis headquarters.

Apps on tap

Infrastructure is only half the equation for USi. The other half is the applications it can push down those pipes and the services that integrate them with a customer's systems.

In choosing its applications, USi went for value to the end user. "The more distributed the user base and the more complex and critical the application, the more it's in our strike zone," Stern says. Sales force automation had a clear value - all those road warriors accessing the home office from hotels - so USi bought licenses from Siebel. E-commerce's complexity made it a natural, so BroadVision and Microsoft's Site Server were selected. Human resources were becoming more distributed as companies set up human resources gateways through which employees can check 401(k) plans and look for approved doctors, so a deal was struck with PeopleSoft.

Financial management was a bit of a stretch, Stern admits, because most users are in the LAN. But a growing number of companies are trying to distribute financial management functions - to hotels in a chain or to new acquisitions - so core financial software was brought on board, again through PeopleSoft.

Recently, USi added Lawson Software, another human resources option, and enhanced messaging with Microsoft Exchange. "E-mail is very distributed and increasingly a very critical function to enterprises," Stern says. "It's not very complex, which makes it a weaker value proposition. But we believe the messaging application area is going to grow to encompass more functions."

Rounding out the software stable is Niku, a billing and resource management solution for professional services.

The high-availability network designed to deliver these applications also made complex Web hosting a natural. USi segments that business three ways: into e-commerce hosting, e-business Internet services and its AppHost program, in which USi provides the back-office functions for a software application that's not part of the company's ASP offering. "In all of these functions, we're offering the same security and support that we give to our software customers," says Stephen McManus, president of the e-commerce business unit at USi. "It's a different model than the UUNets of the world, who provide just ping, power and pipe."

USi usually gets a three- or five-year contract to supply these applications and bills customers an average of $30,000 a month. Monthly charges range from $10,000 for e-commerce apps to $200,000 for some financial and Web site management software. That saves the client company 20% over the cost of implementing the application itself, McCleary says. USi makes an average upfront investment of $600,000 to $1 million per customer. But sharing IT talent among many clients and getting deep discounts on hardware and software preserves USi's margins.

The original target was mid-market companies with $50 million to $1 billion in revenues but without the IT depth to support advanced networked applications. "This isn't necessarily a service for companies that couldn't otherwise afford it," McCleary says.

But USi discovered that it has a surprising amount of traction with some large multibillion-dollar global companies, such as U S West, Samsung's semiconductor group and Excel Capital. While small companies balk at the cost, large ones recognize the savings over implementing the applications themselves.

"Same for e-commerce," McCleary says. "Companies that have already been through one generation of e-commerce understand why an off-the-shelf solution from the local ISP can be a problem."

>From mapping out the customer's needs to turning on the application >usually takes about 60 days, depending on the product. PeopleSoft >integration can take up to 90 days and Siebel can take 45, but USi has >implemented e-commerce applications in much less time. Those intervals are >shrinking as the company learns to standardize into an assembly-line >approach, McKnight says. "Time to market is one of the strongest elements >of our value proposition," he says. "Besides, the faster we get clients >implemented, the faster our revenue stream starts."

Standardization and robustness help dictate the choice of software vendors. USi doesn't do a lot of customization because it doesn't want to manage 100 versions of PeopleSoft. Big developers such as PeopleSoft and Siebel have invested millions in building functionality into their products so that they can be configured with a few switches, not thousands of lines of source code.

Established products take the risk out of the process. That's especially important to USi as the customers' point of contact for software performance; if it goes bad, they'll kill the messenger - or at least beat up his help desk.

During the last year, USi has bought three systems integration firms specializing in the software products it offers. That integration talent is important because the company wants to sell software to departments within a company, not the whole company itself - which McCleary calls "the disaggregated app theory." If the vice president of sales wants Siebel automation and the chief financial officer doesn't, so be it.

Once and future kinks

Just to keep things in perspective, USi had a total of 81 clients under contract by the end of the third quarter. That's up from 44 at the end of the second quarter - but it's still less than a tenth of the customers who bought Siebel software alone. Obviously, no one's locking up the shop on retail software.

But McCleary firmly believes the company is building momentum. "We received about 280% more qualified sales leads in August than we did in June," he says.

One early problem seems solved: getting the software manufacturers to play ball. Where once they declined to consider the ASP distribution model, mostly out of fear of losing control over products, they now seem ready to see ASPs as another marketing channel. "It's night and day," Stern says. "There's not a software vendor out there today that does not have ASPs on its radar screen as part of its strategy."

As for competition, McCleary doesn't acknowledge that USi has any - yet. "There just isn't anyone now, though there may be by early next year," he says. When it comes, it probably won't be from software companies such as Microsoft and Oracle, which probably will be more interested in getting their applications onto desktops in 20-seat offices than in chasing the large, 5000-seat accounts that USi targets.

What will happen to the relationship with U S West if it acquires rival Qwest? "I don't really know," McCleary admits, but says Qwest Cyber.Solutions may spin off into a separate public company. Products may come to the rescue here - some USi offerings may be more suited for resale by LECs than Qwest's. "We have a Microsoft Site Server e-commerce product that we don't see in the Cyber.Solution ASP model," he says.

McCleary discounts a direct threat from the telcos and voice providers primarily for financial reasons: Investors wouldn't like it. "They may subcontract data centers and transport products, maybe to systems integrators," he says. "It's tough for a telco to have a co-primary competency of application support because Wall Street analysts give them no credit for it."

Qwest Cyber.Solutions, a joint venture formed last June between Qwest Communications and consultant company KPMG Peat Marwick, divides the application service provider market into three segments based on the client's size and IT needs.

"We start with applications management, where the large business customer - the Fortune 50 type of account - says, `I just bought all my hardware, and I don't want to abandon or refresh it,'" says John Charters, president of Qwest Cyber.Solutions. This company licenses its own applications and runs data centers but doesn't have the IT resources to manage or evolve the software. Qwest Cyber.Solutions has 450 certified application specialists who will do that, courtesy of KPMG.

The next step up in breadth of service is application hosting. The client licenses software but moves its hosting over into Qwest Cyber.Solutions' seven data centers (with seven more to come before the end of the year). "If I prove myself in the applications expertise, I can move them over to the apps hosting services over time," Charters says. This segment offers market entry into mid-market corporations that haven't made a full-tilt investment in IP infrastructure.

Finally, there's the more traditional ASP model: The company hasn't got the data centers and doesn't want the licenses but rents the whole shebang from Qwest for a monthly fee.

At the low end of the market, Qwest Cyber.Solutions is targeting small companies that plan to get big - and to use big software. "Companies that just have 10 employees want to remain 10 employees and are just looking for productivity software are not our market," Charters says. "But where a company has 10 employees and plans to be a thousand or more, we want to be there and help grow them. They're intelligently looking at their software needs five years down the road, but today, they'd rather spend their capital on the product that is going to get them there than on software licenses."

Exodus Communications won't rent you an application over the Web - but it will hook you up with someone who can.

Exodus wants to be the data host of choice for all the Internet's big names, including its emerging application service providers (ASPs). With 22 data centers online by the end of 1999, including London, Tokyo and Frankfurt, Germany, Exodus already hosts 34% of the 50 largest dot-com e-commerce sites and Internet eminencies such as Hotmail. That is the difference between Exodus and Internet data center competitors such as AT&T or Intel, says Ellen Hancock, president and CEO of Exodus "They want thousands of customers. I want a thousand customers with thousands of servers."

And the drive to get big does not include any plan to turn Exodus into an ASP. "I'm really enjoying not being in that, and I see no advantage in getting into it," Hancock says.

A more viable business model is to offer Exodus' services to the software and application providers themselves, she says. "I can't imagine going to a middleman for what I can get from Siebel, Oracle or SAP directly," she says. "A lot of people say they'd rather go to the person who owns the intellectual capital than to someone trying to keep up with it. The person who's producing the next release knows best what's in it and can do the best job of dealing with the customer."

Exodus currently hosts Web sites for Oracle Business Online and Sun Microsystems' StarOffice, two business application Web sites from which customers can rent productivity software. Exodus also has entered into an arrangement to provide the data center infrastructure over which ASP Corio will download PeopleSoft software to emerging and mid-market companies. In addition, Tibersoft will use the data centers to lease programs for food service companies.

Becoming an ASP would shift Exodus' focus to consumer business, and it would involve going after the same business and the same customers as some of the ASP and software companies it hosts. And with quarterly revenue growth of more than 40% for the last two years, Hancock doesn't see any point in jinxing a winning streak. "We don't compete with any of our customers," she says. "Some of the ASP companies cannot say that."