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This chapter is from the book

Netsourcing Viewed as a Service Stack

Another commonly used framework to understand the netsourcing space is the service stack from an infrastructure perspective. Netsourcing can be viewed as a continuum of infrastructure services, beginning with connecting the customer to a network, through to hosting, application access, and application services. Service stack models help suppliers to position themselves in the netsourcing space, as well as to guide customers through the technical and business aspects of netsourcing. In Figure 1.2 we present our service stack from an infrastructure perspective, which contains the following five layers: network infrastructure, network services infrastructure, hosting infrastructure, application operations infrastructure, and application access. The service stack model immediately highlights that there are many ways to netsource. Customers may netsource only up to the hosting level, then manage their own applications, content, and business processes. Or the customer may look for a full-service provision, which includes all layers of the model. Because many novice customers feel unsure about what types of issues are involved in each layer, we have devoted Chapter 4 to defining all the technical issues associated with each level.

Figure 1.2FIGURE 1.2 Service Stack Model: Infrastructure Perspective

It is also important for the reader to note that there are many variations of the service stack model besides our own. Table 1.1 contains service stack models from Oracle, Gartner Group, and IDC. In addition, EDS's service stack is presented in the EDS case study in Chapter 5.

To understand how the service stack can help suppliers position themselves in the market, we asked Mark Newton, branch manager at Oracle, to explain his view of Oracle's seven-level stack. For him, levels 1 through 3 represent hardware service provision, with only those companies operating in levels 6 and 7 being true business application service providers. According to this definition, an ASP is the organization that is on the hook for the customer's contract. Independent software vendors need to move quickly up the value chain by becoming ASPs themselves or by forming alliances with companies at that level. While those operating at levels 1 through 3 will form a vital provision, the interesting developments will be in the upper levels. Players in levels 6 and 7 are redefining types of market offerings and how best to deliver effectively to specific customer segments. Mark Newton suggests at least two overall markets at levels 6 and 7: as an application service provider, with a one-to-many relationship to small and medium-sized enterprises, or as a BSP aggregator offering a suite of customized capabilities and services to relatively few big corporations.

TABLE 1.1 Service Stack Models

Oracle

Gartner Group

IDC

Customized applications

Customer relationship, general contractor

Process execution

Standard applications

End services (integration, application management)

Process support

Management and support

Data center operations and hosting

Content

ISV applications

Applications and content

Applications

Hardware/infrastructure

Platform

Development environment

Colocation/hosting

Network

Systems infrastructure

Network

 

Network


However the netsourcing market develops, it is pretty clear that suppliers can use a service stack model to think through the ways to position themselves in the space

Which Applications Are Customers Netsourcing?

One of the ways in which the netsourcing space can be evaluated is by the types of applications being bought by early adopters. As of first quarter 2001, our online international survey (see Appendix A) found that the most commonly netsourced applications were e-mail and communications, personal productivity tools, customer relationship management, finance and accounting, human resource management, and business-to-business (B2B) e-commerce (see Figure 1.3). (E-commerce is actually the second most frequently purchased ASP application if the B2C (business-to-customer) and B2B results are combined.) Many people do not consider personal productivity or communication software as business applications, so these are not often listed in other surveys. But a study by IDC confirms our findings—60% of their respondents said they would probably use an ASP for collaborative services such as e-mail, groupware, document management, conferencing, and scheduling.8

Figure 1.3FIGURE 1.3 Most Commonly Netsourced Applications, First Quarter 2001

In addition to our own survey work, a number of IT research and consulting firms are regularly monitoring the netsourcing space, including Forrester Research, Zona Research, Gartner Group, and the Yankee Group. They have found similar results. For example, Forrester Research identified the main netsourced applications as e-commerce, customer relationship management (CRM), manufacturing and logistics, finance and accounting, human resources, supply chain management, product development, and industry-specific applications. In February 2001, the ASP Consortium and Zona posted results of a survey of 137 U.S. senior IT professionals. They found that the most frequently purchased ASP services were communications applications (34% of respondents), finance/accounting (25%), e-commerce (21%), customer relationship management (19%), education/training (18%), and human resources (13%). Applications such as e-commerce, CRM, and communications are ideally suited for hosting because they require unlimited access (ideal for Internet), are usually specifically written for Internet delivery (as opposed to delivering a client–server application over the Internet), and are usually not industry-specific. In the Zona study, less than 4% of respondents purchased ERP through an ASP. It is interesting to note that ASP spending patterns reflect overall application spending patterns. AMR Research estimates that ERP sales will increase annually by only 5%, whereas CRM will grow by 40% annually.9

What Is the Promised Customer Value of Netsourcing?

We have seen the types of suppliers and applications being offered in the netsourcing space, but what exactly is the value proposition to customers? In this section we introduce 11 general benefits promised to customers, which is explored more fully in Chapter 8 once readers are convinced to evaluate netsourcing more closely.

  1. Lower total cost of ownership. The cost is lower because the service provider spreads fixed infrastructure and software costs over many customers (economies of scale). In a Zona Research (2000) study of customers, this was cited as the most important expected benefit from netsourcing. Corio claims that on average, customers achieve a 70% reduction in total cost of ownership (TCO) in year 1, and a 30 to 50% reduction in TCO over a five-year period.

    Two illustrative examples of such benefits being delivered are provided by Zland.com and USI.net. In the Zland case we found one manufacturing firm paying $200,000 to a two-person Web developer team to develop e-commerce and e-marketing capabilities. Ongoing support cost the customer $40,000 a year, representing primarily consulting fees. Zland.com demonstrated that they could provide the same functionality for a $10,000 set fee and a monthly subscription under $1000 (see the Zland case study in Chapter 5). In Table 1.2 the ASP USInternetworking compares the cost of a client's traditional application implementation with its actual USI billed costs. The main advantage from a TCO, then, would seem to be few or no upfront costs in software licenses, hardware, and implementation.

  2. Allows the customer to focus on core work. We have seen this argument used for IT outsourcing generally. Packaged solutions was one move in this direction, but what netsourcing can achieve is a further move toward the commoditization of IT and its management, thus freeing up general employees as well as IT staff for more strategic activities.

  3. Scalability. Another main advantage of netsourcing is that customers typically pay a monthly fee based on number of users or number of transactions. As such, some have called netsourcing a new "pricing model" because customers can adjust IT costs based on incremental increases or decreases in use. Customers can avoid capital investment costs when internal resources reach capacity, or avoid the expense of idle equipment if downsized.

    TABLE 1.2 Traditional Implementation Costs versus USI-Hosted Costs

     

    Traditional Implementation Costs

    USI-Hosted Costs

    License

    $180,000

    $0

    Hardware

    50,000

    0

    Implementation

    480,000

    0

    Initial costs

    710,000

    0

    Operations and support

    20,000

     

    Disaster recovery

    4,000

     

    Bandwidth

    2,000

     

    Monthly costs

    26,000

    36,000


  4. Fewer in-house IT experts. Fewer experts are needed because the service provider can spread expensive IT expertise over many customers. In addition to reducing a customer's internal IT head count, netsourcing can also provide skilled labor not otherwise available. Netsourcing providers can do this at a reasonable price because of economies of skill achievable by utilizing its staff over multiple clients. A service provider will also be more interested in keeping its staff's skills up to date and be able to provide a broader range of skills than most small and midsized enterprises (SME) could keep in-house. However, this advantage is not limited to SMEs. By 2001, even large organizations were experiencing problems retaining IT workers. For large organizations, however, the challenge is not the scarcity of IT people so much as the scarcity of specific skills. As one informant told us: "I was on the west coast with one of our existing large customers and I was asking this question about retaining skilled workers. They said they don't have this problem anymore because there is enough fallout from the dot coms. So they aren't struggling with the scarcity of people, but they are struggling with the specialization of skills."

  5. Faster implementation of business solutions. With netsourcing, applications can be delivered in days or weeks rather than in months or years. For example, ERP and B2B exchanges are available much quicker via netsourcing than if they are installed as a customized solution within an organization. ERP may take between six months and two years on the latter process, whereas enterprise ASPs such as Corio and USI have been known to take 60 to 120 days. USI can also configure a PeopleSoft server with software in 4 labor hours versus 120 labor hours if done without an ASP solution. Such speed can be explained by the reduced degree of customization provided by the service provider but also by the fact that the service provider is placing the software on its own familiar hardware and is able to use software components across clients.

  6. Flexibility. Because customers have less long-term commitment to hardware, software, and perhaps even suppliers, a TCO provides more flexibility. We have noted that the customer's total cost of ownership is reduced in part by investment avoidance. But investment avoidance also keeps the customer's options more flexible because they can easily switch hardware and software. Switching suppliers may be easier with netsourcing than with traditional outsourcing because contracts are typically shorter in duration and based on more commodity-type products and services.

  7. Provides bundled solutions. The bundling of hardware, software, systems development, integration, infrastructure, and their management again simplifies the administrative and decision-making burdens traditionally associated with IT. In this sense the organization is buying not a product or a service but a bundled combination, which, following Shiv Mathur in his 1997 book Creating Value, we could call a systems buy.

  8. Provides powerful computing to geographically distributed organizations. Customers may experience large managerial and technical challenges with mobile, dispersed workers. Netsourcing can simplify and centralize these issues, and provide technical solutions and access to a broad range of applications and computing power at a lower cost.

  9. Reduction of technical risks associated with a fast-growing business in times of rapid technological change. Often, a customer will need to ramp up its use of IT considerably, and service providers can cushion the customer from the usual internal IT problems associated with the need for rapid adoption. Furthermore, service providers can take away the pain and cost of upgrading applications and keeping up with the technological trajectory as improvements and new technologies come onto the market.

  10. Transfer of ownership headaches and risks. There are both financial and technological risks associated with IT, especially where the technology is unproven or is an existing technology in a new application to a specific organization. A service provider will reduce the investment risk, but also the technical risk, not least because it is easier to back out of a netsourcing arrangement if it fails technologically. Reducing such risks becomes particularly important where systems and application failure can have damaging consequences for the conduct of the client's business.

  11. Offers predictable level of IT expenditure. Even where netsourcing does not turn out to be cheaper, large organizations may well be attracted to the stability of expenditure on IT offered by the rental model, especially where IT budgets are more typically volatile and future IT needs unpredictable.

Like all sourcing innovations, the promised benefits must be balanced against the risks. Netsourcing risks—at least as perceived by reticent potential customers in our international survey—include service quality, stability of service provider, security, reliability, and dependence on a third party. These risks, and how to mitigate them, are analyzed fully in Chapter 7.

What Other Values Do Netsourcing Business Models Offer?

A business model is a service provider's plan for generating revenues based on adding enough value to attract customers while still earning a decent profit margin. Four business models are common in the netsourcing space: intermediaries, distribution channels, hosts, and portals. It is important for customers to understand a service provider's business model to assess the long-term viability of the supplier as well as the best sourcing options for their business needs. All four of these models promise the 11 customer benefits discussed previously. In addition to these common benefits, each of the four business models offers customers some unique benefits. Suppose, for example, that a customer needs an ERP system and has decided to netsource. Should the customer use an intermediary, go directly to the ISV's netsourcing subsidiary, purchase the software from the ISV and host it remotely with another service provider, or try netsourcing via a portal? The answer depends on a number of issues, such as whether the customer needs single or multiple applications, whether the customer is looking to avoid upfront software license fees, and whether one-stop shopping is important to them. Each of these four netsourcing business models is examined more closely below.

Service providers as intermediaries.

In the netsourcing space, intermediaries host primarily third-party, best-of-breed ISV software and thus serve as retailers to ISVs (see Figure 1.4). Intermediaries can often provide a better deal to customers than if the customers purchased directly from an ISV. For example, the service provider Lodge (see Chapter 6 for a full case study) will refinance SAP licenses on behalf of customers, which allows customers to select a financing package to meet their needs, such as postponing any payments the first six months into the contract or paying fixed monthly fees.

Figure 1.4FIGURE 1.4 Netsourcing Provider as an Intermediary

Intermediaries may be application specialists by focusing on one type of application. For example, EasyLink (previously Mail.com) focuses on messaging applications and services. The additional value added to customers of application specialists is superior service because the service provider has focused expertise and resources on one type of application.

Intermediaries may be portfolio assemblers by offering several third-party, best-of-breed applications. Three widely known portfolio assemblers are Agiliti, Corio, and USI. The additional value added to customers of application assemblers is lower transaction and coordination costs because the customer has one-stop shopping for several applications and services rather than dealing with multiple ISVs.

Service providers as distribution channels

Many companies that write their own proprietary applications chose to deliver those applications to customers via an ASP channel (see Figure 1.5). The value added to the customer is direct access to a best-of-breed application with presumably superior technical support by the original architects, offered via a low-cost distribution channel. The value added to the supplier is that there are no payments to an intermediary.

Figure 1.5FIGURE 1.5 Netsourcing Provider as a Distribution Channel

The ISV may use the ASP as the only way that customers can access the software, or the ISV may use the ASP as a complementary channel to other distribution channels. In the case study chapters, you will see that Zland and Siennax are examples of ISVs that use ASP as their sole distribution channels. Most of the large ISVs, however, are developing multiple delivery channels, including an in-house ASP subsidiary. ISVs with in-house ASP channels include Oracle, PeopleSoft, SAP, and Great Plains. These companies also relicense to ASPs that act as intermediaries, as well as delivering through their own sales force, consulting businesses, and strategic partnerships. Multiple channels allow the ISV to market to large, midsized, and small firms across geographic regions and industries. Some people may question if the duplicate channels will cannibalize sales, but each channel adds different value to the customer. A customer may want to rent directly from PeopleSoft, for example, if that is the only application sought. But another customer may want PeopleSoft integrated with a customer relationship management package such as Siebel and therefore may prefer to rent both applications from an intermediary such as Corio.

Service providers as hosts

Some service providers host customer-owned applications, allowing the customer to avoid infrastructure investment and to reduce IT support personnel while accessing their own software (see Figure 1.6). For example, FutureLink hosts a customer's software provided that the application is MS Terminal Server or Citrix MetaFrame compliant. Microsoft certainly demonstrated its support in FutureLink's business model by investing $50 million in the company in the fourth quarter of 2000.

Figure 1.6FIGURE 1.6 Netsourcing Provider as a Host

Probably one of the most widely known hosts is Exodus. Exodus offers Web-hosting services to 4500 customers and hosts over 62,000 servers worldwide. Many of Exodus's customers are actually ASPs that host their applications with Exodus to avoid building their own data centers, including Oracle Business Online. More traditional customers that host their sites directly with Exodus include Lenox, Blue Cross/Blue Shield, L'Oreal, and U.S. News & World Report. Exodus reported 2000 revenues of $818 million, an increase of more than 300% from 1999 revenues. However, net losses were $256 million, primarily because of Exodus's heavy investment in new data centers. Consistent with the pattern seen in most ASPs, the stock price had fallen to a 52-week low of $1.18 per share on June 21, 2001 from a 52-week high of $69 on September 1, 2000. (Exodus trades on the NASDAQ under EXDS.)

Service providers as portals

Another netsourcing business model is the portal, which serves as a single point of accountability between multiple customers and multiple ASPs. The portal's added value includes one login and a single point of customer support for multiple applications (see Figure 1.7). The downside of the business model is that the portal does not typically have direct control over the service levels, although it is held accountable for them.

Figure 1.7FIGURE 1.7 Netsourcing Provider as a Portal

The most famous portal is Jamcracker, founded in 1999 by former Exodus Communications chairman K. B. Chandrasekhar, together with Herald Chen and Mark Terbeek. Jamcracker serves as a portal to the following ASPs: Connected, CriticalPath, diCarta, Employease, Entex, Icarian, iPass, Managemark, myCIO.com, OpenAir.com, OutPurchase, Talisma, UnitedMessaging, UpShot.com, USA.net, and WebEx. Accenture (formerly, Andersen Consulting) recently partnered with Jamcracker, which will lend credibility as well as new marketing channels to the portal. Jamcracker's Web site promises the following value to the customer:

We test all the new web-based applications and services as they become available from a variety of partners, and offer only the ones that work best. We help you determine which combination of services is best suited to your needs. Everything is integrated onto a single platform and delivered to your end users through a simple, secure solutions delivery platform that's accessible with a single sign-on from anywhere in the world. Finally, you get continuous 24 3 7 support. Your end users get quick answers directly from us, by e-mail, phone, live online chat, or a service request placed through Jamcracker Central. Your IT department, meanwhile, gets the time it needs to concentrate on more important things, like how to make your company even more efficient and profitable.

(Note that Jamcracker does not consider itself an ASP, but says: "We work closely with ASPs to integrate their services on our platform, offering our customers a broad range of different services.") During 2001, Jamcracker had about 40 active customers and was negotiating with another 40 potential customers. They actively seek companies with 300 to 5000 employees,10 but, of course, know that their margins will be greater by selling to a few customers with many seats rather than selling to many customers with a few seats.

Another portal, Agiliti, decided to abandon this business model in 2001 because the market is not quite ready to purchase multiple applications from a single point of accountability. Instead, many customers instead prefer to test the waters by hosting one or two applications first before escalating their commitment.

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