But Threats of Forward-Integration Abound
Recently we completed a project for an up-and-coming application service provider (ASP) who wants to make a big splash in the market with its new service, which is providing other companies' applications over the Internet to small- and mid-tier business customers who can't or would rather not invest liquid capital in ERP, CRM and others.
The purpose of the project was to identify true competitors and potential partners in what is becoming a very fragmented industry, to produce a module for inclusion in the company's business plan (presumably for future rounds of VC financing), and to identify and better describe its ability to compete in a rapidly changing marketplace.
Before we look more closely at the ASP market, we should understand the term. Software applications, just like Web pages or e-mail accounts, can now be "hosted" on remote servers across the Internet and delivered to users when they need them. The value proposition for users is that they can lease access to complex, expensive software systems over the Internet, rather than pay thousands of dollars per seat for the same applications. It also helps them avoid implementing and deploying the software themselves or hiring consultants to do the work.
What we found out about the market was less than the company were hoping for, however. I've always advocated the role of the competitive intelligence professional as being the "chief truth teller" for an organization. But, in the immortal words of Jack Nicholson, some people just "can't handle the truth!" Most contemporary American business leaders, especially those in pure-play Internet industries, have blinders on to the strengths, weaknesses, opportunities and threats they face. In fact, sometimes they're not that interested in long-term competitive advantage. They're more transfixed by the millionaire-making IPO and eventual exit strategy to their personal island in the tropics.
That's the environment in which ASPs find themselves competing today. The market has evolved from an initial set of leading-edge companies-- Corio, USinternetworking and a few other Web service providers who didn't call themselves ASPs at the time, but do now--striving to penetrate a new segment of a marketplace. Just as cars have largely moved from outright sales to leasing, so goes the software industry in the age of the Internet. A few, including USi, have managed to go public on that business model. The old idea of the product life cycle in business planning was that products and services begin as a means of competitive differentiation and eventually, inevitably become transformed into commodities. It seems the very companies pushing products into the ASP channel are "cannibalizing" the market as a means of fast growth. SAP, Baan, PeopleSoft, Oracle, Siebel--you name it, the ISVs are charging ahead to offer their own ASP pricing and delivery models to the same target market.
The big difference with the ASP sector when compared to most industries--and the whole Internet economy for that matter--is the relatively accelerated nature of product life cycles in an environment with few or no barriers to entry. That is especially true because the companies whose software is being leased through ASPs have long sought a way to penetrate the under-resourced small- and mid-tier companies that previously didn't have the wherewithal to buy their products, but need them just the same.
Today, the ASP segment of the software/services marketplace is rapidly becoming just another means of delivering any kind of software. In our recent market survey, we found that there are more than 750 companies calling themselves an ASP. For the most part, they are old-school software companies who've re-engineered their products to be delivered over the network and managed to work out a leasing contract instead of a purchase agreement. Others are nothing more than Web sites providing database access to off-site storage of files and data that used to be stored on the PC or provided through shared drives on the LAN, for sales and market personnel, financial and HR applications or e-mail and messaging.
The tone of some of the companies has begun to change in realization of the facts of the matter. USi, for example, no longer touts its services exclusively as lease arrangements for access to ERP, e-commerce and CRM software from major league companies. It has expanded its services to include setup and deployment of "managed applications" on its network for software companies--independent software vendors (ISVs)--of all kinds. USi is as much in the business of turning ISVs into ASPs as it is an ASP in its own right. Its positioning is one with substantial meaning for the marketplace. Rather than fend off competitive threats from its vendors' plans for forward integration into its market, it's embraced its core competencies in "cannibalizing" itself before competitors can.
That is a perfect example of Internet competitive dynamics--to continuously adapt strategy to ever-changing needs of the marketplace--in this case, the assumed and eventual threat of forward integration from vendors. Those unique qualities being brought to market include the deepest knowledge of any firm in the ASP business (because it's one of the oldest in the category), having yielded one of the best developed data management networks and some of the deepest understanding of service level agreements (SLA) in the industry. Service level agreements are likely to be the sole product differentiator for ASP service ranges.
While the market is expected to reach some $23 billion worldwide by 2003, according to recent studies, USi's 109 customers at the end of 1999 represented $158.3 million in long-term contracts--equivalent to some 36% of the total market size as of today's most recent market statistics. That's a relatively small pie to get a piece of so far. But through a strategy of diversification and, in effect, becoming the ASP's ASP, a company like USi might stand to make a better game of going after ISVs trying to enter the new channel than in simply renting other companies' applications in competition with them.
Another ASP is Portera Systems, leasing Oracle Financials and HR applications to professional service firms. Larry Ellison said he'd never let Oracle's applications be sold through the ASP channel--and, so far, he's stuck to his pledge ...with the exception of Portera, who numbers Oracle among its investors. Portera calls itself a "vertical service provider" to keep Ellison off its back.
So, what's my advice to our ASP client? Focus on competencies that your company can provide and that are really in need of representation in the market. The market trend we've identified is forward integration by ISVs into the market to capture segments previously unavailable to them. They are software companies not network service providers. When they can partner with a service vendor that can drive revenue from unexploited Internet opportunities, they'll have a winning approach to customers and vendors alike.