What does it take to succeed in the hosting market? Some combination of size, capital, staying power, innovation, and, for vendors that sell other products, synergy with the core business. Loudcloud Inc., which last week sold its managed hosting business for $63.5 million to IT services vendor EDS, had innovation, but lacked scale and ran out of time to make it on its own. Intel, which also disclosed plans to exit the hosting business last week, has the size and resources, but its services weren't especially innovative or a natural fit with its chipmaking business.

These were high-profile casualties: Loudcloud was the brainchild of Netscape cofounder Marc Andreessen, and Intel poured hundreds of millions of dollars into building its global hosting operation. But the failures don't mean hosting is a flawed concept. EDS, the second-largest hosting provider, according to Tier 1 Research, says its hosting business was worth $3.5 billion last year. And while hosting and other on-demand services account for less than 10% of IBM Global Services' approximately $35 billion in revenue, they're growing at double-digit rates. Doug Elix, a senior VP and group executive at IBM Global Services, expects that growth rate to continue for the next few years.

IBM is the No. 1 hosting provider, with 17% of the market. It already hosts Web sites, storage capacity, and business-process applications such as procurement for customers, and is further expanding its services. Next month, it will disclose plans to let customers lease capacity on Linux-based mainframes that it owns and operates.

Indeed, the hosting market is thriving. Forrester Research predicts revenue in the managed-hosting market-which includes the monitoring and management of hosted systems, as well as other services-will reach $30.8 billion by 2006, up from $5.6 billion today. The research firm expects storage outsourcing, a $451 million market, to more than double by 2004.

U.S. businesses operate an estimated 97% of all IT systems in-house, according to Tier 1 Research. That creates immense outsourcing opportunities for companies looking to cut costs. For example, companies can save 40% to 60% by outsourcing a Web application, says Andrew Schroepfer, president of Tier 1 Research.

For Encyclopaedia Britannica Inc., it would be too expensive to provide round-the-clock support for all of its Web operations. "The more traffic a site gets, the more likely we are" to have it hosted," says James Glenski, director of system operation and design. The Chicago company would need 41 IT staffers to keep all its Web operations running in-house 24 hours a day, as opposed to nine now with most of its high-volume sites outsourced.

Still, the hosting market is consolidating. Just a couple of years ago, it was hard to keep count of the number of companies springing up to provide Web-site, database, E-commerce, applications, and storage hosting and management. But the numbers have fallen sharply, with once fast-growing players such as Exodus Communications being gobbled up by other vendors or shutting their doors entirely.

But the shakeout may be a good thing. "Consolidation has made the stronger ones better," says Dan Agronow, VP of technology at The Weather Channel in Atlanta. The Weather Channel uses WorldCom to host its domestic and international Web sites, a wireless service that provides weather data and alerts over the phone and on PDAs, and an application that consumers can run on their desktops to find out about severe weather in their areas.

Though WorldCom has its own financial troubles, Agronow says the company has shown it's serious about its hosting efforts, and that gives him confidence. "They are making the investments to make sure their infrastructure is top notch," he says. "They're not jumping into business because there's quick money to be made."

Convenience store chain 7-Eleven Inc. uses EDS for its critical infrastructure hosting, including various application servers, portals, and ordering, supply-chain, financial, and data-warehousing systems. It wouldn't consider outsourcing those functions to a smaller company. "Our core financial systems are so mission-critical that we need the best provider on the planet," CIO Keith Morrow says. "We want deep pockets."

Size also matters when it comes to turning hosting into a profitable venture. Smaller companies such as Loudcloud simply don't have the resources or the economies of scale to meet the hosting business' capital requirements, say some experts. For example, because of its larger size, EDS can get discounts on hardware that aren't available to smaller hosting companies, says Jeff Kelly, president of global hosting services at EDS.

IBM's vast resources-computer hardware, software, consulting services, and data-center facilities-work to its advantage in the market, says Dev Mukherjee, VP of strategy for IBM's E-business hosting services. "If you're a new company coming in, there's an awful lot of stuff you have to do just to get started," he says. Adds Elix, "You'll never get to a point where you can make money unless you can build scale."

Intel seemed as if it would be able to do that: Analysts say it had already built three data centers and paid for space in at least four others since launching Intel Online Services in 1999. The company even saw promising growth in the business, and analysts believe that Intel had hundreds of customers. But a spokeswoman says Intel decided to shut down the unit because its growth and profits didn't meet goals.

The chipmaker was aiming high. "I expect this will be a multibillion-dollar business for us eventually," CEO Craig Barrett said in January 2000 (see "Inside Intel," Jan. 17, 2000, p. 38). Now, a year and a half later, Intel says it will turn out the lights in its data centers in 12 months-between now and then, it will work with customers to move their operations back in-house or to another provider.

It's become clear that basic hosting services such as simply co-locating computers in a shared facility are "stick-a-fork-in-it dead," Loudcloud's Andreessen says. To be successful, "you've got to be high-end, serving high-end customers, and you've got to be at scale," he says. "And if you can do all three of these things, it's a nice business."

By September, Loudcloud and EDS expect to transfer all 50 customers of Loudcloud's $75 million hosting business to EDS, along with 140 hosting employees. Loudcloud will change its name to Opsware Inc., after the name of its software, which automates IT administration tasks for hosting companies, IT service vendors, and business customers.

As part of the sale of the hosting business, EDS will pay $52 million to license Opsware for three years. Kelly projects that EDS's Web-hosting business will break even this year and turn a profit in 2003, thanks in part to $100 million in savings expected from using the Loudcloud software.

Opsware begins its reincarnation as a smaller company with about 100 employees and this month will ship the first commercial version of its software to EDS and four other customers, two large financial companies and two large government agencies, Andreessen says.

Because EDS will use Loudcloud's administration software, the deal gives customers the best of both worlds, says Debbie Freedman, VP of BellSouth technology operations, which uses EDS for service management at its own data centers. BellSouth hopes to use Opsware to set up Internet applications. The software "is ahead of its time" in how it coordinates applications with the Internet, Freedman says. "I look at the hosting side as being able to extend your capability-it's a natural synergy."

Amid the changes, some customers are re-examining their hosting arrangement. StatementOne Inc. in Lawrenceville, N.J., which provides investment account consolidation services for brokerages and financial-services companies, used Loudcloud to host and manage its applications. Greg Pacholski, president and chief operating officer at the company, says he's now asked his managers to review the managed-service landscape, "just to refresh our understanding of the market."

For now, Pacholski is waiting to see whether any of the people Loudcloud is laying off were technicians who helped support his business. "I'm concerned. We're watching it very closely," he says.

With few exceptions, niche hosting providers will lose ground to larger, more-established vendors, says Corey Ferengul, VP at Meta Group. For smaller providers, the best ways to survive will be through partnering to add necessary skills or by focusing on a specific technology or vertical market, he says.

The market is shifting. But hosting still has its appeal, as long as there are businesses around that have pressing needs and not enough resources to meet them. The last thing The Weather Channel wants to do is let down the folks who turn to it, whether to figure out how to dress their kids for school or to get a potentially lifesaving alert about dangerous weather conditions heading their way. Says Agronow, "We need to make sure that when they need that information, it's available." -with John Foley, Tischelle George, and Rick Whiting