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Now They're Selling Service

Application service providers are beginning to realize that service is their middle name.

1Apr

For executives at Sterngold, the rise of the Internet was nothing to smile at. Despite more than a century of dominance in manufacturing restorative dental products, the company watched helplessly as competitors gnawed away at its business with slick Web sites that provided reams of product data and a convenient way for busy dentists to order products online. A strong response was vital, but with only two people in its IT department, the Attleboro, Massachusetts- based company felt toothless in the face of E-business.

It was a situation tailor-made for an application service provider (ASP), and, in fact, Stern-gold did tap one for an E-commerce system that could bring its more than 4,000 products to the attention of Web- savvy dentists the world over. But the way in which the company shopped for a partner and structured the deal may be more noteworthy than what the software can do, for it says much about the changing nature of ASPs.

Almost unheard of two years ago, today ASPs are deemed by some to be in their "second generation," a rapid maturation that has occasioned considerable growing pains--with more to come. A widely quoted prediction by analyst firm Gartner holds that 60 percent of today's players won't be around by the end of next year. But corporate customers will likely find one source of solace: the hundreds of companies that survive will be keenly focused on service in a way their ex-competitors were not.

For that, thank such companies as Sterngold, which are sending a strong signal to the market that what they want is not only faster, less-expensive access to software, but also a working partnership with their ASP that emphasizes service. Sterngold evaluated a number of companies, from IBM to Pandesic, the high-profile alliance between SAP and Intel whose collapse last summer snapped the ASP world back to reality. Ultimately, it chose a product called OneCommerce, from OneSoft Corp., in McLean, Virginia.

Sterngold could have struck a deal directly with the vendor, which, like many software companies today, gives customers the option of buying the software outright or renting it in an ASP model. But Gordon Craig, director of marketing for Sterngold, says his company decided to access the software through an ASP called Surebridge Inc., of Lexington, Massachusetts, because Surebridge could provide better service at lower cost. "They're local, for one thing," he says. That made a difference, because Surebridge devoted nine staff members to the project, many of whom spent time at Sterngold. "The travel and hotel expenses for OneSoft people would have added up," says Craig. "Plus, it's nice to work with someone local; you can get together anytime you have an idea or a question."

It wasn't merely that those nine staffers came without airfare and hotel expenses attached, however; it was the fact that Surebridge was willing to throw so much manpower at the job. That allowed Sterngold, late to the Web, to get up and running with E-commerce capabilities in about 15 weeks. And Surebridge made sure that the company's customer service, long an important competitive advantage, translated well to the Web environment. "We wanted all the things that companies usually want from ASPs," says Craig: "a turnkey system that's easy to use, flexible, scalable, and that gives us a lot of power without a big capital outlay up front."

RELATIONSHIPS WANTED

But Sterngold wanted something more from its ASP: advisory services and a close working relationship that would help it deploy other applications down the road. The company sees its foray into E-commerce as a first step in creating a much more efficient supply chain, says Craig, and it wants a technology partner to help build that chain.

Surebridge met Sterngold's needs on both software selection and service. The ASP offers applications from more than half a dozen vendors, and while it believes that acting as a "one-stop shop" is a critical part of its strategy, its success ultimately hinges on what sort of relationship it can build with clients over time. "If we do a good job supplying one application," says Surebridge founder and chairman Pradeep Khurana, "then we feel that the rest of the [client's] business is ours to lose."

Khurana proudly notes that "in three and a half years of doing business, we have won almost 100 customers and never had one leave us." Surebridge assigns a "client partner" to each customer, a person whom Khurana characterizes as "almost a CIO-level employee." The company also points to cross-trained teams as another competitive weapon. "We can get a client up and running faster than other ASPs can," maintains Khurana, "because we send in a smaller team made up of people who can each tackle two or more aspects of an implementation," versus larger teams made up of people with narrow specialties.

A year ago, it might not have occurred to prospective clients to inquire about the makeup of an ASP's implementation team, or the exact qualifications of the person acting as the principal point of contact. Now it does. "Cost still matters," comments Joe Wetz, director of business technology at Magellan Health Services, in Columbia, Maryland, "but once you look past the slick marketing programs that all the ASPs have, it comes down to service: Who are you most comfortable doing business with?"

Like Wetz, most customers admit that saving money is still a major part of the ASP appeal. But most also agree with him that, in the long run, ASPs may not be much cheaper than buying the software and running it in-house. Audrey Apfel, vice president and research director at Gartner, says that speed of deployment and lower up-front costs are driving most ASP business today; total cost of ownership may prove to be higher with an ASP, depending largely on how long the application remains useful. Companies like avoiding the capital outlay that an outright purchase requires, and the predictability of the monthly fee is another big plus. If the monthly fees do accumulate, Khurana says, so too will evidence that the ASP is a strategic partner, not a commodity supplier.

Wetz says that Magellan decided to acquire Lawson Software's procurement and financial products through ASP market leader USinternetworking Inc. (USi), of Annapolis, Maryland, in large part because of the many services that USi could wrap around them. Some of those are the "traditional" advantages of an ASP: flat fees, a technology infrastructure that is more advanced than what Magellan could afford, and a large staff of IT specialists.

But Magellan was also swayed by USi's ability to handle all help- desk inquiries for the Lawson software. "We didn't want to get caught in a lot of finger-pointing among USi, Lawson, and our own staff," says Wetz. "That USi is able to handle that aspect of service is a big part of its appeal."

Gartner's Apfel says that service-level agreements also should emphasize service. "Don't get hung up on a lot of meaningless numbers," she says, referring to uptime statistics and similar metrics. "Match the service to your business needs: Is it available when you need it, with performance good enough to get work done on time? If you can measure that in real time, you'll have an early-warning system that will serve you well."

Magellan had used ASPs before, for travel and entertainment expense management, and found the arrangements worked well. Its deal with USi, however, is far bigger than that niche application, and promises to become more so. "We will provide Internet access to more employees so they can access the Lawson software," says Wetz, "and we're already considering acquiring more software through USi." To date, the kinds of software that are most popular in an ASP model include infrastructure and administrative applications, which require little customization and are rarely deemed strategic.

ONE THROAT TO CHOKE

USi and Surebridge operate on largely the same model, although they rarely compete, because Surebridge is aimed at the midmarket, while USi pursues larger companies. Both companies offer a range of software, from ERP to business intelligence. Both claim that while they hope a successful engagement will lead to further business from each client, their profitability does not depend on selling multiple applications to each customer.

Some analysts aren't so sure, though. They say that the economies of scale needed to thrive as a software middleman work against renting a single application to a customer and bundling it with lots of service.

Andrew Stern, CEO of USi, admits that "confidence in our long-term viability is customers' top concern," but he can point to a number of positive signs: half of his company's customers have bought additional capacity, and a quarter have signed on for more than one application. He adds that since the average client has been with USi for less than a year, that 25 percent figure is a sign of things to come. And he says that while USi did post a $12 million EBITDA loss in the fourth quarter on revenue of $37 million (including a $3 million charge resulting from the early termination of a contract with US West), the firm also landed $49 million worth of new business in that quarter.

More indicative of the current state of the ASP industry may be the reorganization that USi underwent. The company laid off 11 percent of its workforce in January, but vows that this will not harm its service levels. "We've gained so much experience," says Stern, "that we've cut implementation times by 25 percent. And we've automated some processes. Configuring software on our servers used to take 120 man-hours. Now we push a button, and it's done in 4 to 5 hours."

Therefore, he says, USi can afford to shed workers and not only maintain current service levels, but also play a more consultative role with clients. Harry Fox, vice president of E-business at Coventry Health Care Inc., in Bethesda, Maryland, is one customer who believes USi's business model is sound. "I wish its stock price were higher," he says, "but its service has been so good that we may outsource other applications to it as well." Coventry tapped USi for a three-phase implementation of an E-commerce system, and Fox says USi got the contract because "they can do it all, from front-end design to integrating new technology with our legacy systems." That soup-to-nuts capability was essential, says Fox, "because we wanted a general contractor, a single point of accountability." (Or, as Surebridge's Khurana puts it, "one throat to choke.")

Many customers express similar sentiments, and don't welcome the prospect of renting a dozen applications from a dozen different ASPs. But some consultants believe the one-stop-shop model has certain risks, particularly where high-end ERP applications are concerned. For example, Kevin Green, managing partner at Cherry Tree & Co., an investment bank in Minneapolis, says that ASPs that resell applications made by others are to some degree beholden to those software creators for much-needed technological modifications. "It's one thing to access an application over the Web," says Green, "but that's a long way from truly 'ASPizing' the software so that it can provide a full range of functions to multiple clients who are connecting to it."

Smaller ASPs that develop the software they rent have an inherent technological advantage, asserts Green. These second-generation companies may not be able to solve all a client's IT challenges, but what they do, they do very well. "The ASP model really focuses on business needs, not IT needs," he says. "If you solve a particular problem very well, that may count the most. A CEO may feel that as long as each business unit is getting value from its ASP, that's enough."

"It's appealing and sexy to offer a full suite of products," says Larry Burns, president and CEO of StartSampling Inc., a marketing and promotions company based in Carol Stream, Illinois, "but very hard to execute. It leads to cookie-cutter solutions that don't fit." So when Burns and his CFO, Seamus Heneghan, went shopping for ASPs, they had no qualms about opting for smaller, highly specialized companies. They rented Great Plains's financial software through an ASP called Scitor Solutions, and data analysis software from Primary Knowledge Inc.

Primary Knowledge typifies the ASP business model that Green and other analysts say is on the rise. The New York company develops its own software and acts as its own ASP. Many traditional software companies have rushed to create ASP divisions, often with dire results-- JD Edwards and 3Com both got out of the ASP business almost as soon as they got in--but Primary Knowledge was built around the ASP delivery model.

Peter Adams, the company's chairman and CEO, says that means his firm can customize the application to suit each client quickly and cheaply, since the company created it. And by providing the software in an ASP model, Primary Knowledge can offer small companies such as StartSampling the number-crunching power of a huge data center that is far beyond what the nascent dot-com could afford to buy.

"The [ASP] market is overbuilt," says Adams, "particularly in the professional services model, where a company provides lots of people to set up applications that come from someone else. Lots of these firms simply have more capacity than they can sell, and they'll be consolidated into a few big players."

AFTER THE SHAKEOUT

At the same time, most analysts believe the ASP concept is certainly viable, if not transformative. Despite its prediction of a substantial shakeout, Gartner says that by the end of 2005, the ASP market will reach $24 billion. Research firm IDC is far more conservative, predicting that the ASP market will reach $8 billion by 2005--still a stunning growth rate, given that IDC says that ASPs pulled in only $300 million last year.

Those mixed signals add to a confusing picture of the ASP market, which seems to be simultaneously gaining momentum and losing its luster.

"Everyone expected last year to be the Year of the ASP," says Stephen King, founder and chairman of Virtual Growth Inc., an accounting and bookkeeping ASP. "I think it will be evolutionary. We'll never have a Year of the ASP, but as people get more comfortable with it, it will become a major fact of corporate life."

Sterngold's Craig is clearly a fan of the concept, but he's not taking any chances. His research into the ASP market convinced him that it would be in flux, at least in the short term. So, to guard against unpleasant surprises, he arranged to have the source code for the OneSoft product put in escrow, and his company developed a transition plan in case it needs to move to another ASP in the future. "We have complete faith in Surebridge," says Craig, "but you can never know what will happen."

Primary Knowledge's Adams doesn't believe the one-stop shops will disappear. Neither does Laurie McCabe, a vice president at consulting group Summit Strategies, in Boston. "We'll end up with a blend of solutions," she predicts, "from vertical service providers like Primary Knowledge to firms that offer a broad range of software from many companies."

McCabe adds that while the market remains confusing for many would- be buyers, the competition affords them the chance to push for better terms on price and service. The array of choices also means that customers will deal with ASPs differently, depending on what they're used for.

Take StartSampling, for example. Says CFO Heneghan: "I call the ASP that provides our financial apps once a year, because it runs fine. But we talk with Primary Knowledge a lot, because that's a specialized application that's close to the heart of what we do, so we want to leverage its expertise as much as we can."

Scott Leibs is technology editor of CFO.

MODEL BEHAVIOR

As ASPs enter their second generation, significant differentiation is under way. Kevin Green and his colleagues at Minneapolis investment bank Cherry Tree & Co. say that those ASPs that survive will do so by augmenting the hosting and managing of software with value-added services. The most common strategies adopted to date include:

Domain expertise, in which the ASP specializes in human resources, procurement, or some other relatively narrow business function that tends to be similar across various industries.

Security infrastructure ASPs, which apply multilayered security products to a client's E-business systems.

Vertical expertise, in which a company concentrates on a given industry, tackling the issues most strategic
to that industry.

Infrastructure focus, with an emphasis on monitoring, testing, maintenance, and security of networks, databases, and related systems.

Vertical exchange emphasis, in which the ASP hosts an exchange that allows various entities within a supply chain to share information and conduct transactions.

"Hot app" players, ASPs that offer software created by other vendors that prefer to concentrate on developing products and selling direct, leaving it to ASPs to derive additional revenue through that model.

Full-service providers, which not only rent applications but also provide consulting, integration, and development services.

Aggregators, which manage relationships with a number of other ASPs, and provide a customer with a single point of contact. -- S.L.

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