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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.
The Top of the Software Heap
(Figures are for most recent 12 months)
COMPANY PROSPECTS
MICROSOFT The No. 1 maker of operating systems and PC applications is still
the 800-pound gorilla. But watch out for the Justice Dept.
hunters.
ORACLE Maker of database software is betting that hosting software jobs
for companies will encourage them to use Oracle products while
paying a service fee to boot. But waylaid in March by earnings
shortfall because of execution, rather than strategy problems.
COMPUWARE Averaged 30% growth over the past five years. Consensus for
fiscal 2000 sees a 33% earnings jump. Provider of testing
software and services must avoid being hurt by Y2K-related
slowdown in corporate buying.
SAP Analysts expect the maker of software for big corporate jobs to
post only modest 1999 profit growth. But new products promise big
upside in 2000.
RATIONAL Wall Street forecasts a 29% earnings gain in fiscal 2000 for the
SOFTWARE maker of object-oriented software tools that help companies build
programs faster.
NINTENDO Kids say Nintendo 64 is ''da bomb''--meaning cool--and new game
Pokemon is huge. But the real payoff may be expanding the
technology into information appliances.
NOVELL Novell has bounced back on the strength of its powerful
networking software, which puts a company's entire network under
central control. Look for 20% sales growth this year--a far cry
from the 21% plunge between 1996 and 1998.
BMC Its software for maintaining heavy-duty computer systems is still
SOFTWARE a big seller, but BMC must cut its reliance on slow-growth
mainframe market.
DASSAULT Look for about 20% 1999 profit growth for the French maker of
SYSTEMES computer-aided design and manufacturing programs. Acquisitions of
Chrysler and Nissan by European carmakers push Dassault into U.S.
and Japan.
UNIGRAPHIC Analysts expect more profit gains from this design and
SOLUTIONS manufacturing software firm. Big growth areas: service
offerings and European demand
SALES SALES PROFITS
(MILLIONS) GROWTH (MILLIONS)
MICROSOFT $17,217.0 26.0% $6940.0
ORACLE 8,296.5 24.2 1,165.2
COMPUWARE 1,638.4 43.8 349.9
SAP 5,327.5 46.5 576.2
RATIONAL 411.8 32.6 59.2
SOFTWARE
NINTENDO 4,455.0 27.8 697.0
NOVELL 1,117.7 26.4 116.8
BMC 1,303.9 65.4 364.3
SOFTWARE
DASSAULT 510.7 51.6 108.6
SYSTEMES
UNIGRAPHIC 422.8 27.4 27.5
SOLUTIONS
Oracle: Again, a Trendsetter
It tries its hand at the
pay-as-you-use software market
When it comes to trends in
the computer industry, Oracle Corp. always seems to be in the vanguard. It popularized the
easily searchable database and pioneered the notion of tapping into complex corporate
information from Web browsers. Now Oracle is at it again. This month, with the launch of
Oracle Business OnLine, the company will start offering customers the ability to tap into
software programs running on its own computers.
This is a radical departure for one of the software-industry giants. In the past, Oracle
licensed its finance, manufacturing, and human-resources software to customers and
supplied consultants to get it running smoothly. Now, clients who license the software can
have Oracle keep the programs and information on Oracle computers that dish out the
programs to them over the Internet. No more hassles in day-to-day operations. And pricing
is based on the number of users.
For Oracle, the business has obvious appeal. It gets to have its cake and eat it too--by
selling the software and then collecting ongoing service fees. The company hopes Oracle
Business OnLine opens up a market among midsize companies that have not been able to
afford Oracle's pricey software. ''This is a big opportunity and the wave of the future,''
says Oracle CEO Lawrence J. Ellison.
Oracle's not the only corporate software maker to give this a whirl. Microsoft Corp., for
instance, is allowing hosting services to license its database software and then offer it
to corporate customers on a pay-as-you-use basis. Oracle's strategy, however, has a twist:
Rather than partnering with so-called application service providers that usually offer the
service, Oracle will basically go it alone. It plans, though, to hire allies to house some
of the computers. The company figures that eventually up to half of its customers could do
business this way.
Not all Oracle-watchers are certain it will succeed at this business. Albert Pang, an
analyst for International Data Corp., says Oracle lacks experience running a hosting
service and predicts the competition will be brutal. ''This might be a good, quick way to
get applications up and running, but (Oracle) is not the only game in town,'' he says.
So far, though, Oracle's pilot customers like what they see. Robert Mondavi Winery in
California's Napa Valley expects the system to free technical workers to do other tasks.
While transferring its human-resources information into an Oracle application was
time-consuming, the service has run smoothly, says Senior Vice-President Steven Soderberg.
If all goes smoothly for Oracle, it may spin the new unit off as an independent
company--perhaps with a Web-size market valuation. First it has to prove that it can run
big data centers as expertly as it writes software programs.
By Michael Moeller in San Mateo, Calif.
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