Take my apps - please

The application outsourcing market appears poised for growth as small to mid-size companies buy into the plan, but larger firms have yet to follow.

By PAUL MCNAMARA
Network World, 05/31/99

Might your company be missing the boat on application outsourcing? The seductive pitch from a rapidly expanding list of Application Service Providers (ASP) goes like this: Let us handle your enterprise e-mail, virus scanning, enterprise resource planning (ERP), electronic commerce and other applications and you'll save upfront money, deployment time and, perhaps most valuable, precious IT staff resources. Moreover, your costs will be more predictable, operational and end-user support more dependable, and painstaking software upgrades a thing of the past.

Enticing though this may sound, most network executives have so far resisted the temptation to outsource applications. Despite all the predictions of a pending boom in the ASP market, these professionals say they are unwilling to bet their businesses on the performance promises of third parties outside of their immediate control.

Newer, smaller companies without massive investments in legacy IT systems represent an exception to the rule. They are increasingly willing to outsource applications, according to industry experts, who expect this willingness will soon spread to established organizations of all sizes.

According to International Data Corp. (IDC) in Framingham, Mass., spending on high-end outsourced applications, such as ERP and e-commerce, will grow from an estimated $150.4 million this year to $2 billion by 2003, a compound annual growth rate of 91%.

The Gartner Group in Stamford, Conn., predicts e-mail outsourcing alone will blossom from its current $400 million per year to $1.2 billion annually by 2001, presuming no significant advancements in service offerings will be made. If, however, service providers can overcome the technical reservations of potential customers - security and advanced e-mail functionality are mentioned often - that market could rise as high as $2.56 billion, Gartner says.

Here's another sign of momentum: Earlier this month, 25 companies, including Cisco, UUNET, Citrix Systems and Exodus Communications, announced the formation of a consortium that will attempt to create standards for the ASP industry. And some vendors are throwing real money at the ASP idea. In a deal with Qwest, Hewlett-Packard is investing $500 million to outfit Qwest "CyberCenters" throughout the country with the hardware, software and services necessary to offer application services, the first of which will be SAP's R/3.

All this activity comes despite previous conspicuous application outsourcing failures, such as AT&T's effort to peddle Lotus Notes and Novell NetWare services in the early '90s, and an MCI attempt to do the same with Microsoft BackOffice. However, experts say the maturation of the Internet coupled with ever-expanding bandwidth and advanced security technology gives today's outsourcers the ability to succeed where their predecessors failed.

The need for maximized speed to market will drive e-commerce application customers into the arms of ASPs, according to Meredith McCarty, senior analyst with IDC's Internet Services research program.

"There is a great pressure on organizations to deploy e-commerce applications rapidly," McCarty says. "Many organizations do not have this talent in-house and are more likely to outsource this function" as opposed to more established IT "sacred cows."

Quote.com, an online provider of real-time financial information since 1993, fits the profile of today's typical ASP customer. Last year, the Mountain View, Calif., company realized it was having trouble properly handling the 400 daily e-mails it was receiving from visitors to its Web site.

Quote.com sought help from eGain Corp. in Sunnyvale, Calif., whose Email Management System automatically responds to incoming Web site e-mail and/or routes it to the appropriate employee within an organization. Companies have the option of buying the product or letting eGain host their implementation.

"We looked at the option of implementing Email Management System ourselves - the benefits vs. the costs - and it made a lot more sense to me at that stage to outsource," says Kaj Pedersen, vice president of engineering at Quote.com.

Handling the application in-house would have cost Quote.com about $80,000 in upfront costs, of which $50,000 would have gone to a full-time administrator, Pedersen says. The $50,000 the company wound up paying eGain was, therefore, a bargain. But more important was keeping a time-consuming customer service task off the plate of Quote.com's 44-member IT department.

"We still need to own the relationship with the customer, but we don't have the [organizational] bandwidth to develop that kind of sophisticated [e-mail] technology," Pedersen says. Quote.com is also exploring the possibility of outsourcing its customer registration and billing systems.

ERP - a prime candidate

The outsourcing of ERP applications, although a small piece of the overall ERP market today, promises to be fertile ground for ASPs in coming years, industry experts say.

Dinwiddie Construction in San Francisco, whose most recent high-profile project was the J. Paul Getty Museum in Los Angeles, is one large company that has already taken the plunge. The company has been outsourcing J.D. Edwards ERP applications for several years through World Technology Services in Seattle. Dinwiddie, a $500-million business with 650 employees, uses J.D. Edwards' general ledger and cost-tracking applications.

"On the dollars-and-cents side, it seemed to us that there were some economies of scale and economic benefits of going to the outsourcing mode," says David Miller, Dinwiddie's controller. "The real hurdle for us was more of an emotional one in that we would be giving up control over a very, very, very important business application."

Miller estimates the outsourced applications have cost his company two-thirds the price of deploying and administering the same systems in-house. However, he, too, sees additional benefits to outsourcing that do not necessarily show up on the bottom line.

"There were benefits to having our MIS people focus on our project-oriented needs as opposed to general financial payroll-type applications," he says. "It's hard to put a price tag on outsourcing those headaches to someone else."

That's a sentiment shared by Alan Fraser, CEO of Virtual Networks, a maker of voice and data communications platforms in Sunnyvale, Calif.

"We're trying to be the ultimate virtual company," Fraser says of his 120-employee operation. Part of that strategy involves outsourcing PeopleSoft ERP applications through Corio, an ASP headquartered in Redwood City, Calif.

Virtual Networks considered several options before outsourcing with Corio, according to Victor Ahluwalia, Virtual's director of finance. Buying and deploying the PeopleSoft applications in-house would have cost roughly $1 million and taken one to two years to fully implement, he says. A less-expensive alternative from Great Plains Software in Fargo, N.D., was weighed but ultimately rejected, Ahluwalia adds, primarily out of concern that it would not scale long-term to meet the growing company's needs.

"At the end of all that, we came to the conclusion that the best solution for us would be to outsource this if we wanted to be ready for the long-term," Ahluwalia says. Virtual sees outsourcing as a way to provide a first-rate, highly scalable set of applications without having to hire new staff or worry about deploying future upgrades.

Drawbacks and hesitations

Skeptics argue that outsourcing can cost a company more in the long run than swallowing hefty initial deployment costs. This may be true, Virtual Networks executives say, but it's not reason enough to tip the scales in favor of deploying the applications in-house.

However, there are other potential drawbacks in any outsourcing arrangement, Fraser acknowledges.

"The obvious one is that you don't have direct control over what's going on and you do vie [with other customers] for resources within the outsourcing company," he says. "Unless you treat this like a relationship that you must build and foster, you're going to end up having problems, just like you would with any supplier."

While some who shun outsourcing complain that it does not give a company the option of customizing their applications, Fraser sees this alleged drawback as a virtue.

"If we did the applications in-house, we might be more likely to start customizing, which I absolutely do not want people to do," he says. "Having spent a fair bit of my career in large corporations, I know the kinds of headaches you get and the lack of flexibility you end up with when you start going down the customized route."

These testimonials to the virtues of application outsourcing do not sway everyone, of course.

"It's nothing that we would ever do," says George Taylor, a network administrator at Black Hills Health Care Network in Spearfish, S.D., which has 800 employees spread over nine locations. "The main reason is that we have enough expertise in-house to run the system right, so why pay someone else to do it?"

Security concerns, however, also contribute to Taylor's reticence.

"I hate to just come out and say I wouldn't trust [an outsourcer], but there is very much a concern about confidentiality because this is health care," he says. "We can't take the chance of someone seeing a patient record."

As president of Software.com, Valdur Koha has a stake in seeing the outsourcing industry overcome such objections. His Santa Barbara, Calif., company makes highly scalable e-mail servers used by ISPs.

"One of the big hurdles, of course, is the question of whether I want mission-critical data to be outside my firewall," Koha says. "As people get more comfortable with that and see that it's safe to do, people will opt to outsource." Confidence levels are rising, he says, with the emergence of name-brand ASP players armed with legally binding service-level and security agreements. Stronger encryption technology, a must for secure outsourcing, is also playing a big role.

Weighing the options

His own company will soon be among those jumping on the bandwagon, Koha says, as Software.com intends to sign on with an e-mail outsourcer he declined to name.

"We certainly are very knowledgeable when it comes to e-mail," he says. "We can run our e-mail environment, but what we cannot provide at a reasonable cost is 24-7 technical support. If a server crashes on a Saturday, I've got to page somebody to come in to reboot."

Even service providers have to face the question of whether to build their own application infrastructures or resell the services of a larger outsourcer.

"We've gone through that decision-making process twice now [for e-mail and fax] within the last year," says Jon Crumrine, product manager for application services at Intermedia Business Internet, a network services provider in Beltsville, Md.

The e-mail decision came down to a choice between buying and deploying InterMail Server from Software.com or reselling the service through Critical Path, an e-mail outsourcer based in San Francisco.

"Obviously, there are merits to both," Crumrine says. "We decided that strategically it would be better to go ahead and build our own. . . . If you decide to outsource it, you lose an element of control."

Many of those who do outsource argue that the control issue is overrated. Remote management tools offered by outsourcers give them the most important control, they say, which is the ability to administer end-user accounts.

Rick Lazer, network engineer in charge of messaging at Skadden, Arps, a New York law firm, sees just that balance in an e-mail content filtering and virus scanning service called MailZone from AllegroNet of Dayton, Ohio. Skadden, Arps also outsources Internet e-mail connectivity to AllegroNet.

"In this case, we feel the service offers great ease of management and great flexibility with little administration involved," Lazer says. "If we wanted to, we could bring that in-house and maintain the servers ourselves and deal with the updates of the virus signatures, but it's a lot easier to outsource."

MailZone provides rules-based e-mail filtering designed to stem the flow of frivolous .avi files and executables that can bring a corporate messaging environment to its knees, particularly around the holidays. The service is blocking 500M bytes worth of nonbusiness related e-mail attachments every week, according to Lazer.

"All I need on my side is a browser to actually manage MailZone when I do need to manage it, such as releasing messages that shouldn't have been blocked or adding users who need to be excluded from the block," Lazer says.

E-mail outsourcers say they've had more success attracting customers to supplemental services such as MailZone than they have in convincing companies to outsource complete messaging systems. AllegroNet reports the MailZone customer base grew from 200 to more than 800 companies since the beginning of this year.

Outsourcing has clearly captured the fancy of newer companies, but will their bigger and more-established brethren really be following suit any time soon? A lot of IT industry heavyweights are betting they will, as brand names such as Cisco, BellSouth and the Sun/Netscape alliance have recently launched their own outsourcing initiatives.

"To my surprise, we know about a couple of very large customers who are seriously looking at outsourcing" their e-mail, says Software.com's Koha. "One has 60,000 employees - a big international corporation - and the other one has 120,000 or 130,000 employees."

Virtual Networks' Fraser believes it's only a matter of time before such companies take the plunge. "It's going to be imperative for them to do so, or they won't be able to compete with the new companies that are really agile and flexible."