| BUSINESSWEEK ONLINE : JUNE 21, 1999 ISSUE | ||||||||
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| COVER STORY
Suddenly, Software Isn't a Product, It's a Service Application service providers are changing the way programs are sold and delivered In February, Robert Eminian had no time to waste. After six months of debate and two trips to Seoul, Korea, the San Jose (Calif.)-based vice-president of Samsung Semiconductor Inc. had the O.K. to build an online wholesale mart for memory chips--a potentially huge advantage in a market dominated by Asian competitors that are reluctant to sell on the Web. But buying the computers and software to set up the virtual marketplace would cost $2.5 million. Worse, getting the Web site and complex software running perfectly could take six months. Eminian had the $2.5 million. But he couldn't count on his competitors dragging their feet forever. Eminian found a better way. Instead of buying the E-commerce software, he rents it. And instead of marshaling a half-dozen companies to supply computers, configure the E-commerce software, set up the network, design business processes, and manage the system day-to-day, he turned the whole thing over to one company, which plans on launching the chip mall in a matter of weeks. ''When we saw how we could offload some of the headaches, the decision process was quite short,'' says Eminian. ''Doing it this way, we're ahead of everyone in our market.'' Eminian's experience with his Web site heralds a sea change in the software world. It used to be that big projects meant big, costly software programs--bloatware in tech parlance. No more. A new breed of companies called application service providers are transforming software from big, expensive, often nettlesome products, into a more affordable and easy-to-use service. Think of it as the difference between building your own home and hiring a general contractor who manages the plumbers, carpenters, and electricians. In this software-services world, GTE Corp. is the early leader with annual revenues from such services approaching $100 million. Now, companies ranging from startups like USinternetworking Inc., which is building Samsung's E-commerce site, to traditional software makers to tech consultants are using services to rewrite the rules of the industry. How does it work? These companies provide all the support and computers at their own facilities. More important, they often will take complex corporate software packages and scale them down so they are simpler to set up and manage. Rather than take many months, even years, to get giant programs installed, these service providers can do it in three months or less. ''A REVOLUTION.'' The goal: making sophisticated software as readily available as flipping on a light switch. According to Forrester Research Inc., the market for such services could total $6.4 billion by 2001, up from less than $100 million last year. Says industry consultant Tom Kucharvy of Summit Strategies Inc.: ''The changes make (E-business) so much easier and so much less expensive that it has the potential to create a revolution.'' There's a long tradition of service companies managing their clients' computing systems--the so-called outsourcers like IBM and Electronic Data Services. But what's different here is the Internet. Through application service providers, software can be quickly made available. Users can gather and update information from their applications via simple Web browsers. That means even those who have recoiled from complicated software can feel comfortable and be trained quickly. Another improvement on the old outsourcing model: The data traffic is carried over public networks instead of far more expensive private lines. The software is changing, too. Software service providers are using more standardized packages, replacing, in many cases, custom programs that require small armies of programmers to support. That means service companies can also devise simple methods for handling all of their clients' applications, driving costs even lower. But it's not just about the money. Corporations freed from managing complex computing projects can focus on more important things. Web portal Excite Inc. farmed out its financial-management software to startup Corio Inc., based in Redwood City, Calif., so it could concentrate on customers. And Sunburst Hospitality Corp. turned over its PeopleSoft financial-management program to USi so it could devote more time to launching a chain of extended-stay hotels. Clients also are freer to experiment with new strategies and suppliers. Because Samsung is paying a little more than $10,000 a month to USi, the company can afford to take a chance on an untested online store that it thinks could generate $100 million in annual sales. Indeed, Samsung is one of the early adopters. The software service movement didn't really gain steam until USinternetworking went public in April, commanding a $2.5 billion first-day market valuation in spite of its order backlog at the time of only $2 million. Now, two other software-service providers, Interliant Inc. and Digex Inc., have filed to go public. Corio raised a fresh $21 million from venture investors, including Kleiner Perkins Caufield & Byers. And software makers as big as SAP and Oracle Corp. have made major announcements (page 138). Even telecommunications upstart Qwest Communications Corp. is entering the software-services business. Meanwhile, Andersen Consulting has put more than 500 people to work in this area. ''It's something we have to do to stay competitive,'' global managing partner Hugh F. Morris says. For now, there's not a huge threat to the established consultants--who typically make their profits on large and expensive software set-up jobs. After all, Corio has just six customers and USi had only 30 as of March, 23 of whom signed up during the first quarter. Of the 6,000 corporate customers of Denver software company J.D. Edwards & Co., only 23 rent software. Says Kirsten Berg-Painter, marketing vice-president of Clarify Inc., a San Jose-based maker of customer-relationship management software: ''It's been very much vendor-driven.'' Don't be fooled by the small numbers, though. The momentum behind software services is building. It's attractive to software companies because while selling software is highly profitable, peddling software packages costing upwards of $500,000 can be a tough, costly business. Software makers such as SAP and PeopleSoft rely on a small number of big sales to hit their quarterly financial targets, and their stocks can take a beating if a few customers slip from one quarter into the next. Multiyear service deals create an annuity that lets software makers know where their next quarter's profit is coming from. And it's an appealing business for software-hosting startups. These service specialists are looking at a sweet business model. Using standard software eliminates many of the labor costs that have made traditional computer systems integration more a series of specific assignments than an efficient business. Chris McCleary, CEO of USi, says his company spends an average $300,000 to $400,000 to get each new customer set up, mostly on labor to perform the limited customization that rented software allows. With full-service rates ranging from $10,000 to $75,000 a month, it's not hard to see how McCleary will get his money back. Legg Mason Inc. analyst Todd C. Weller says a software-service company is likely to command gross margins of 40% to 50%. SECURITY JITTERS. The real payoff for service providers comes with stability. A good service provider can know more about a client's operations than the client does. McCleary's model is the payroll processing giant Automatic Data Processing, where the average client relationship lasts more than a decade. Calling in a software-service company is not without risks for customers. Forrester Research says IT managers worry that sensitive information will be pilfered or that outsiders won't be able to keep networks up and running as consistently as they should. Even companies that are outsourcing some of their software, like the car-parts maker Delphi Automotive Systems, share the concerns. Chief Technology Officer Gary L. Robertson says he has been reluctant to turn over Delphi's critical SAP system to outsiders. ''We can't operate if that goes down,'' Robertson says. But the beauty of turning software into a service is that services are flexible. Providers can work with customers like Robertson. He's turning his SAP software over to an outsourcer to run over a virtual private network. That solution is less exposed to breakdowns than one that runs over the Net. It's the ability to give each customer what they need that could make the new software world take off. By Timothy S. Mullaney in New York, with Peter Burrows in San Mateo, Calif. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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