Outsourcing Monster in a Box

FRAMINGHAM (05/01/2000) - The leash on technology spending and control is slipping from the CIO's hand. The factors that have ensured the CIO's participation in technology buying decisions will soon go away. All that will be left for the CIO is accountability if something goes wrong.

The culprit is a seemingly harmless fad called ASP (application service provider). Broadly defined, the concept is the delivery of a software application over a network (such as the internet) using "pay as you go" pricing. Primarily targeted at small or midsize companies that cannot afford their own IT departments or computing infrastructures, the ASP offering is compelling. You get a fully functioning, big-time application--such as enterprise resource planning software--and access it through the internet or a private network without having to pay for the installation, the hardware or the software. Just pay a monthly fee that amortizes the ASP's costs of installing and maintaining the application over time--as well as a healthy little profit margin.

The ASP model of leasing applications (contracts generally run between one and three years) is having the same impact on small and midsize companies that the car leasing market is having on income-challenged car buyers--it lets them sign up for more powerful, sophisticated applications than they ever could have dreamed of owning outright. Of course, the same kinds of downsides apply: no equity, very little control over the applications and some potentially harsh consequences for opting out before the contract expires. Yet all of that bad stuff is lost among the relentless hype and utopianism that surround what even ASPs' harshest critics acknowledge is a nice concept.

"ASPs are doing for applications what the internet did for data. They are making them universally available, affordable and easier to deploy," says Traver Gruen-Kennedy, chairman of the Wakefield, Massachusetts-based ASP Industry Consortium (www.aspindustry.org), which, in its one-year life span, has already ballooned from 25 to more than 300 vendor members.

So far, the Fortune 500 has mostly resisted the entreaties of this hot market (expected to reach $7.7 billion worldwide by 2004, according to IDC, a CIO sister company). But the ASP reach into small and mid-market companies is establishing a solid sales and referral foundation that will eventually spark an irrevocable change in the ways that all companies--regardless of size--buy technology.

Here's why. The ASP sales pitch removes the two primary barriers that have kept businesspeople from buying technology on their own. First to go is technology complexity. Buying software has always meant having to buy at once all the technology necessary to support it--networks, hardware, support software. ASPs remove that complexity from the equation--theoretically, at least--by providing all the supporting technology themselves. Businesspeople buy a business service--customer service, human resources and benefits, logistics--rather than a software application and all that goes with it.

The second banished fear factor is risk. Pay-as-you-go pricing takes the economic burden of buying software (upwards of $100 million for a big ERP system for a big company) and transfers much of it to the ASP. There are no big consulting fees or hardware purchases up front, just a monthly fee. The sheer terror of sinking millions into a software application with no guarantees of success made businesspeople think twice before buying without at least getting IS input first. With an ASP service, they can go directly to the CFO with a contract stating the monthly fee--a much less terrifying number.

ASP vendors make no bones about their target audience. "We don't sell to the CIO, we sell to the businessperson," says Christopher Terry, president and COO of HostLogic, a startup ASP in Boca Raton, Florida. "We don't see IS as our friend. We want a progressive manager who understands that his or her role is managing the relationships with technology providers. If the CIO is protecting a [technology] empire, then he is our enemy."

Another vendor says that CIOs don't enter the picture until the business has already narrowed its options. "We interact with CIOs on security, scalability and adequate service levels. But we usually don't talk to them until we're into the deal," says Graham Lubie, executive vice president of Celarix, a Boston-based ASP specializing in logistics. "Once the end users find there is value, then they bring in IT to make sure we're not just another dotcom startup."

Most ASPs have an advantage in the small and midsize companies they target now because they have a skeletal IS department if they have one at all, and they may not even have a CIO. But big-company CIOs are at risk of being left out in the cold when the concept moves upmarket because they don't have the resources to offer alternatives to ASP products. The talent pool for qualified IS people--especially in hot areas like electronic commerce--is so tight that CIOs face a difficult choice: bring in outsiders like ASPs (with their attendant risks) or hold up the business while searching (often in vain) for qualified staff to do the needed work.

The corporate urge to put business services on the internet has turned into a stampede. Stan Lepeak, a research analyst for Meta Group in Stamford, Connecticut, remembers getting a call from a well-respected Fortune 500 pharmaceutical company that wanted to develop an e-commerce site from scratch in days and weeks--not months. "They wanted a shortlist of ASP vendors from me in a week, and they wanted to have the site up and running in six to eight weeks," he recalls. "They just wanted to focus on marketing and branding and didn't care about the applications. We needed to tell them there wasn't a vendor that could cover all their [technology] needs."

But soon there will be. ASPs are going to add to the pressure Fortune 500 CIOs already feel to become closer allies with the business--or risk losing their jobs. Indeed, if CIOs wait until the ASP market really hits the Fortune 500 before they get closer to the business and begin acting as a trusted adviser--rather than as an arm's-length technology supplier--it will already be too late. Many CIOs say the ASP phenomenon is just the latest bit of evidence supporting the need to transform themselves from geeks into business thinkers and solution providers. "It is my responsibility to be a consultant to my business partners about solving their problems and not just be the technology geek," says Ken Harris, senior vice president and CIO of The Gap in San Francisco and a CIO editorial adviser. "ASPs don't add anything new to that issue."

Like most Fortune 500 CIOs, Harris has not yet bought into the ASP market, nor is he convinced that ASPs are ready for the heavy transactional demands and sheer complexity of a big company. But he is paying attention. "You have to consider the possibility of ASPs," he says. "You have to consider them in a whole bunch of emerging areas, like e-procurement, and in some more traditional areas, like general ledger or financial processing."

If CIOs don't take an active role in consulting to the business on ASPs, they, not the businesspeople, will suffer the consequences. "If the CIO hasn't done a good job educating businesspeople about what ASPs are really offering, the problems will come home to roost with the CIO," says Lepeak. "There is such a shortage of IS talent right now that ASPs will get business regardless of whether they can live up to their promises." here are plenty of promises being made. Startup ASPs are offering turnkey solutions for complex ERP software without having a single "live" customer.

Many are getting in the game by linking various specialty providers together in complex ASP supply chains. One partner may provide data storage, for example, while another offers web hosting services, and a third provides the application. Startup ASPs are inking complex contracts with each of these various providers for service and then packaging it all under a single umbrella. While this is probably the business model that all ASPs will have to adopt if they wish to be able to scale their services to meet the needs of multiple Fortune 500 customers, the linkages will be fragile until the ASP gets a few deals under its belt and irons out the inevitable service kinks among its various providers.

Meanwhile, some young ASPs, starved for those critical customer referrals, are giving away their services just to get in the game. Host Logic's first customer, for example, was Florida Atlantic University, which will offer SAP's R/3 ERP application to its accounting and business students through an internet link provided by HostLogic. The donation of services from HostLogic and SAP are acts to be admired, but for Fortune 500 companies such profitless deals offer little comfort when considering handing over mission-critical services to a new vendor.

With venture capital money burning holes in the pockets of hyperaggressive investors, new ASPs are springing up overnight to meet the need for leased applications. But with so many new entrants into a complex, unproved market, the repo man is lurking behind every corner. The shakeout among ASP players will be swift and brutal, predicts GartnerGroup. Of the current lineup of 300 or so ASPs, more than 60 percent will disappear before the end of 2001, due to poor service or market consolidation. Indeed, the market is rife with speculation that many ASPs are purposely signing up low or no-profit customers simply to gain market share and look attractive to potential buyout companies--which Meta Group believes will be the major outsourcers like IBM, Computer Sciences Corp. and Electronic Data Services.

But perhaps the most troubling aspect of the ASP market for big companies is that many ASPs are building their profit margins by offering commodity versions of popular software. By severely limiting the customization of complex applications like ERP, ASPs can install the software more quickly and serve many different customers from the same set of application servers, thereby reducing their cost. That kind of model works fine for small and midsize companies, where legacy applications are few and small staffs can adapt themselves more readily to the business processes built into the software. But for big companies with complex business processes and big portfolios of legacy applications that need to exchange data with the ASP application, the need for customization is a given.

"The data [from the ASP application] has to get to your legacy systems and get converted," says The Gap's Harris. "I don't know how you do that without [customization]. If ASPs are being presented as turnkey solutions that don't require IS involvement, then the market won't have much of a future."

For big companies that have their own IS infrastructures and staffs, ASPs will play a much different role than they do for small and mid-market companies. Big companies need ASPs to fill small, specialized gaps in their application portfolios quickly. Cost cutting is not the big lure here--the decidedly mixed results of traditional Fortune 500 outsourcing deals have proved that farming things out doesn't always lead to lower costs. "This is not a total-cost-of-ownership sale," acknowledges HostLogic's Terry. "It's a sale based on time to market and core competencies and people."

It's also a sale that will cause radical shifts in responsibility and accountability for IS. In traditional outsourcing deals, most if not all of the shipped-out stuff was a known quantity--legacy applications and infrastructure that internal staff had built and supported for years. But ASPs are usually brought in to fill gaps in IS's application and infrastructure portfolio. The IS staff may not have any background knowledge of the applications and infrastructure that ASPs handle for them.

That could cripple IS's support pro- cesses and damage its image with the business. Employees accustomed to calling IS with any kind of computer service problem may resist or become confused when told to call an outsider for support--especially if IS does not set clear boundaries about whom to call on for help under what circumstances.

Even if the boundaries are clear, IS becomes a communicator rather than a doer in the ASP equation. And the feedback loop becomes more deeply layered. When the ASP-hosted e-commerce site goes down, for example, CIOs won't be able to respond to internal complaints until the ASP responds to their complaints. With most ASPs gravitating toward becoming complex supply chains of providers bundled together, the ASP may have to make quite a few phone calls itself to find out what's going wrong. If CIOs do not carefully manage businesspeople's expectations for service and support, their departments' credibility could be harmed.

Worse, with ASPs selling their services directly to businesspeople, IS may not have any opportunity to influence the business decision before it gets made. Rather than contributing to a positive discussion about adding new business capabilities to the company, IS has only a tactical role: sussing out the ASP's ability to keep company data secure and to integrate it with new ASP applications. Especially on the security front, IS may find itself the technical terminator--busting up ASP deals when the vendor can't provide adequate security for sensitive data that has never before left the safe confines of the company network.

Again, expectations become everything. If IS doesn't define the security and infrastructure integration issues to the business early in the process, the CIO will inevitably be painted as the naysayer who's bogging down the project.

Now is the time for CIOs to take the lead on the ASP discussion, while the market is immature and still relegated to the small and midsize company markets. "It's safe and necessary for the Fortune 500 to start thinking about the ASP model because it will become an important part of the technology landscape for all enterprises over the next five years," says Audrey Apfel, vice president and research director for GartnerGroup.

"The offerings, the providers and the market are fractured and immature at this point," she adds. "It's not yet time for the Fortune 500 to jump on the ship, but the ship is definitely coming in this direction."

Christopher Koch is eager to hear your ASP stories at ckoch@cio.com.

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