ASP overview: Is application outsourcing a viable option?

Oct 4, 1999
Thomas Pack

A $6 billion dollar market by 2001—that's the forecast Forrester Research made in "A New Lease" several months ago for the application service provider (ASP) business. Forrester also predicted that 15 to 20 percent of packaged application software licenses will be in the form of rentals by that year.

Companies such as USinternetworking, Inc. also believe a growing number of organizations will want service providers to manage and deliver application capabilities to them from centralized data centers across a WAN, eliminating the need to buy and manage the applications locally.

USinternetworking is an Annapolis, MD-based firm that has a wide range of software for rent, including packages from PeopleSoft, Siebel, BroadVision, Microsoft, and Sagent Technology. According to Michele Perry, USi's vice president of marketing, the company was the first ASP in the market and has seen phenomenal growth. "The first half of this year, we did $55 million in contracts," she said. "If you track that versus the early years of the whole packaged software business, our growth curve is much steeper."

But now some of the original fever for the ASP business has cooled. Forrester has revised its forecast, saying the market will take at least until 2003 to reach $6 billion, as many companies are reluctant to get involved. But IT managers willing to weigh the pros and cons and carefully compare costs may find that application outsourcing does offer significant benefits.

Customer reluctance
"In our customer base, so far we haven't had a lot of clients beating down our door saying, 'We want to have someone host our applications for us,'" noted Jim Holincheck, an analyst with Giga Information Group. "Where we have seen it—and I'm speaking mostly about ERP applications—it tends to be companies that are either Internet startup organizations or smaller companies that are planning on growing quickly."

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Holincheck said organizations are reluctant to try application outsourcing because the concept is radically different from traditional outsourcing. "With, say, payroll outsourcing with ADT, what you're really doing is providing some inputs to ADT. It goes away and does its processing based on those inputs, and then it provides some outputs back in the form of information or checks. With a hosted application, the company using it is still running the application. The company is setting the parameters. It's doing business with the application. The only thing the company isn't doing is hoarding the servers that are running it, doing technical support for the applications, and doing upgrades. So it's definitely different from the traditional sort of outsourcing," he said.

"People are concerned about security," Perry said. "They're concerned about network performance. And they're concerned about somebody else having their data off-site."

But is that fear justified? Is application outsourcing safe for mission-critical applications? "I guess it depends on how you define mission-critical," Holincheck said, "but that's certainly one of the key stumbling blocks the providers have to get over for their prospective customers."

According to Holincheck, not only must the providers convince the customers that outsourcing is going to be secure from a network standpoint—they also need to make sure that, from an application perspective, reasonable safeguards to segregate and secure data are in place, especially in situations where there may be more than one customer on a machine running the application. "Technically, I think outsourcing is safe, but security definitely is one of those factors that make potential service provider customers wary," he said.

To address customer concerns, Perry said her company's representatives "go through USi's whole architecture with them, and we show them what we have as far as a service-level agreement. It quickly becomes apparent to the customer that it makes too much sense not to rent applications."

Key benefits
One major benefit of ASPs is that they can help companies get applications up and running in one-third to one-half the time required for traditional implementations. But that certainly isn't the only advantage, according to Perry. "Not only are customers able to get applications faster," she said, "they're going to get better applications that are going to stay up more often, and they're very cost-effective."

Another benefit, Holincheck said, "arises from the fact that there often is a skill issue in implementing ERP applications. If you want to use one of the big vendors like SAP or Oracle or PeopleSoft, building the necessary skills and retaining them in those products can be relatively expensive, and a lot of companies in the middle market—companies with from $100 million to $1 billion in revenue—don't necessarily have a lot of depth on the bench as far as support resources go. So there's potential risk of losing key resources and being able to replace them. Being able to put some of the onus on the application service provider is attractive in some of those cases."

He added that using an ASP is attractive because "to some degree, you reduce the need for technical support; obviously, you're outsourcing much of the support to your service provider. Depending on the arrangement you come to with the provider, you also may be able to do the more functional- and application-oriented support there as well. But, still, there always is going to be a certain amount of internal support that's necessary. From the router on in is still the responsibility of the company. So you don't necessarily outsource 100 percent of the support in these arrangements."

Of course, the potential to reduce costs is one of the most attractive benefits. "The up-front investment for an ERP application often is pretty high for many companies," Holincheck noted. "Pricing for a lot of the ASP offerings basically is a per-user or per-employee per-month model, so application outsourcing spreads out the cost over time as opposed to incurring it all up front. It's not yet clear if it's an overall more compelling cost proposition than doing it in-house, but certainly, as far as predictability of cost, it's a little bit cleaner," he said.
Comparing costs
"When you're looking at in-house costs," Holincheck said, "you're looking basically at hardware, systems software, application software, implementation costs, including both the internal personnel costs plus any consulting costs, and then ongoing support costs. And you need to compare that over a period of time, on an apples-to-apples basis, to what your ASP would provide.

"The ASP is basically going to charge you a fixed cost per month for the term of the contract, which is typically 24 to 36 months. It's usually useful to do the comparison maybe even longer than the term of the contract just because the useful life of these applications tends to be a lot longer than two to three years. The hard part is making sure you're doing an apples-to-apples comparison, and making sure you understand all the things the ASP will do and will not do—and you need to understand what your costs would be to do or not do those things as well."

Holincheck also pointed out that CIOs signing with an ASP should make sure there are specific performance and service stipulations in the contract, including guarantees for application uptime, response time, help desk support, and how upgrades will be handled. "It's funny," he said, "a lot of the service-level agreements are the types of agreements you have if you're an IT manager negotiating with your user community. These agreements also are similar to what you would expect in traditional data center outsourcing."

The pros and cons of application outsourcing

Benefits:

Faster access to new applications.
Lower and more predictable costs.
Fewer administrative headaches.
Less need for support professionals.
Organizations may be able to try an application before buying the entire package.

Drawbacks:

IT managers give up control of part of their infrastructure.
Security concerns haven't been thoroughly addressed by some companies.
It may be a hassle to get an ASP to make modifications to the software.
Cost savings can be difficult to determine.
The concept hasn't been widely tested.

The third generation of applications
Perry is optimistic that application outsourcing will live up to the level of current predictions. "We see this as the third generation of applications," she said. "The first generation was 'build.' The second generation was 'buy.' That's when the packaged applications came on the market. And this third generation is 'rent.' Build, buy, rent—it's just a natural evolution."

She added, "Today everyone wants everything faster. Everyone wants everything on Internet time. You don't want to wait for anything, and that includes applications. So the old way of getting applications after a year or two is just not acceptable for the way life is these days, and this ASP model is the solution to that. It's the fastest possible way to get applications."

As for the initial reluctance to use ASP, Perry pointed out that many more companies will be willing to rent applications once the concept has been widely tested. She noted that today "a customer will say, 'Wow, I can get the system I want. I can get it really fast. It's guaranteed to stay up every month or I don't pay for it. It's cost-effective.' And they think it sounds too good to be true, but once they try it, they say, 'Why wasn't I doing this before?'"

According to Holincheck, two things will need to happen before application outsourcing becomes a major trend. "One is just the whole value proposition relative to the cost of the offering needs to be better defined—or it just needs to be better, period. It still is not a very compelling proposition relative to some of the in-house options available today. The other thing that has to happen is the products need to mature. There's a lot of things a company such as EDS has learned about providing outsourcing over many years—things that are relatively new for some of the startup players in the ASP market," he said.

Holincheck continued, "So I think it's going to take some time for some of the vendors to go through the learning curve before they can provide the necessary comfort level for mainstream customers. We're definitely in the early adopter phase right now. But there are some valid reasons why companies would want to consider moving in the direction of outsourcing applications. Once the vendors smooth out some of the rough edges, using an ASP will be a very viable solution for midsize companies."

Thomas Pack is a freelance technology writer.