Merger, Acquisition Planned As ASPs Realign Business Models
The application service provider ecosystem is beginning to experience Darwin's theory of natural selection firsthand. Some players have been bolstered by their parent companies' strengths, while others have struggled to prevent their cash wells from running dry. Harsh reality has forced ASPs to acknowledge that they must adapt their business models or suffer the consequences.
Analysts contend customer adoption of ASP services has been slower than initially projected, causing some ASPs to experience cash-flow difficulties and Wall Street to push back. There are large up-front capital costs associated with deploying customers on enterprise applications right now since most ASPs have not established a significant degree of repeatable processes, according to analysts. In addition, customers aren't looking solely at what application packages they can outsource. They want a vendor that understands their business processes--something many horizontally focused ASPs don't possess, according to Bob Stimson, VP of Internet distributed services for Merrill Lynch. It's no wonder IT advisory firm Gartner predicts that approximately 60% of the 1,500 ASPs in existence today will go out of business or be acquired in the next 12 months.
To circumvent that fate, ASPs are expected to undergo a dramatic realignment of their business models during the coming year, says investment firm CE Unterberg Towbin. As part of that realignment, ASPs will add business-process capabilities to their application offerings by becoming more focused on vertical industries. In doing so, they will also be able to create templated services tailored to those industries, thereby decreasing the amount of customization needed for each implementation. Portera Inc., an application service provider that offers its own professional services automation software, next week will reveal that it plans to acquire Maxwell Business Systems Inc., a provider of accounting and professional services automation software for government. Agilera Inc., an ASP that peddles third-party enterprise software to the retail and financial industries, will disclose that it will acquire AppliCast Inc., an ASP that sells SAP, Agile, and Siebel Systems software to the manufacturing industry. Corio Inc. is in the process of establishing its own vertical strategy as it renegotiates its contract with PeopleSoft Inc.
Agilera had just completed its $85 million second round of funding in August when Wall Street analysts started whispering AppliCast's name in Agilera president Rob Unger's ear. Unger realized he needed to deepen his company's vertical-industry expertise and customer base if he wanted to remain a viable player in the ASP industry. A merger would be a perfect way to accomplish both tasks. In October AppliCast CEO John McGrory started looking for another round of funding for his ASP. He had already raised about $26 million in two years. Wall Street recommended a union between Agilera and AppliCast to McGrory, having seen synergies in the two companies' strategies. A short time later, the two met. A letter of intent to merge was signed just last week.
AppliCast will be able to take advantage of Agilera's ties to hosting vendor Verio Inc.--a major investor in Agilera and provider of its hosting facilities--and its close, though not exclusive, ties to the DigiTerra integration unit of Ciber Inc. With only enough cash to last another two quarters or so, AppliCast either had to merge or find funding fast. Unger was attracted to AppliCast's installed base of 27 customers, which, when added to his 39, would make Agilera look better in the eyes of the investment community. In addition, AppliCast's business knowledge of the manufacturing industry and technical acumen with SAP and Siebel made it a perfect fit.
InViso Inc. and Tilia Inc. both turned to AppliCast for ASP services because of its vertical-industry expertise and application implementation know-how. "It was a big risk for us to go with AppliCast because we were putting our business in their hands," says Bill Seymour, CFO for InViso in Sunnyvale, Calif. "But we were confident because they had a good handle on the applications and our industry." Seymour says his company, a startup that's developing mobile display devices, was concerned about the coming trend in ASP consolidation. "We felt AppliCast had solid backing and a solid business model, so we figured either way they'd come out all right," he says, noting that he's happy about its merger with Agilera. "Now they're on more solid financial ground," he says.
Analysts predict Agilera has a good shot a being a premier ASP player, if it continues to focus on vertical-industry expertise and works to tightly integrate its application offerings. "I wouldn't be surprised if Verio gobbles up Agilera should the ASPs' business model succeed," says Pascal Aguirre, VP and global practice leader for strategic consulting firm Adventis. Aguirre points to Qwest Cyber.Solutions as another prime example of an ASP positioned for success. Qwest Cyber.Solutions leverages the data centers and connectivity it needs from Qwest Communications International Inc., which holds a 51% stake in the company, and the technical and business expertise it requires from KPMG, which holds a 49% stake. By leveraging its parent companies' strengths and receiving discounted rates from Qwest, Qwest Cyber.Solutions is arguably the most profitable ASP in existence today, according to Aguirre. As more technology heavyweights claim their stake in the market, such as IBM, for example, the pressure is on vendors to play up their strengths and develop business and application expertise.
Keith Knutter, director of IT for Tilia, the producer of the FoodSaver product line, faced a similar situation. Knutter evaluated Corio, Agilera, and AppliCast earlier this year for a Siebel customer-relationship management implementation. "Corio didn't have the business expertise we sought, and I couldn't understand how they could justify their high price with out that," says Knutter, who says Corio's prices were twice that of AppliCast's. Agilera, he says, also didn't have a deep enough understanding of the manufacturing business.
Application vendors are realizing the need to verticalize their ASP partner strategies as a result of customer demand for such business knowledge. The enterprise applications vendor is taking a hard look at its partners, according to Deepak Gupta, VP and general manager for PeopleSoft eCenter, the ASP division of PeopleSoft. "We'll probably swap some out over the coming months," he says of those ASPs that haven't signed up many PeopleSoft customers. "We're turning to all our partners and asking them if they're getting a vertical strategy," says Carolee Gearhart Harari, VP, channels, who notes that PeopleSoft is looking to partner exclusively with vertical ASPs now.
Corio is renegotiating its contract with PeopleSoft to include vertical product offerings and the ability to sell to larger customers. The current contract only allows Corio to go after clients with less than $250 million, CEO and president George Kadifa says. "We're looking into their vertical strategy and what vertical application suites we might be able to offer," he says. "We are trying to understand how much out-of-the-box software from PeopleSoft is vertically oriented." He says he doesn't believe it's necessary to hire people with business knowledge from any vertical should they go with a vertical strategy. "This is about applications."
Portera Inc. is taking a different approach with its professional-services-automation applications. Many of the executives from Portera have worked in the consulting field and understand the business processes of the professional-services industry. Portera, which closed a $50 million round of funding last week, bringing its total funding to more than $100 million, built its own software to peddle in an ASP model. It's expanding and deepening its knowledge of the industry by purchasing 10-year-old Maxwell Business Systems.
Maxwell CEO Sassan Chakmain says his company was looking to host its applications for customers, but quickly realized that it didn't have the resources or expertise to do so. Maxwell customer Leslie Gilbert, director of finance for Booz-Allen & Hamilton, spoke to Maxwell about its hosting strategy. "We were interested in looking at the hosting model, but we were worried that if Maxwell tried to do it on their own, it would drain resources away from their core business," says Gilbert, Maxwell has done some development work on its products for Booz Allen.
Brettina Zwerdling, senior analyst for AMR Research, says software from professional-services-automation vendors such as Portera and Maxwell is natural fits for the ASP space. "The people that use these products tend to work remotely, so being able to log on and access them from anywhere is a key advantage," she says, noting it may be an easier sell than some other ASP-hosted software packages. There are very few professional services automation applications in the government sector, and Maxwell has the most comprehensive one, according to Gilbert, who evaluated several vendors in 1994 when the company selected Maxwell. "Surprisingly there still aren't many solutions available to us other then Maxwell," she says. Maxwell has more than 100 installations of its software and about 100,000 seats sold.
Gaining vertical-industry expertise and applications for those industries is one small part of what ASPs will need to do in order to remain viable players. In the long run, analysts say, the infrastructure that applications run on will need to mature, as will the applications themselves, so that it's easier and more cost-effective for ASPs to deliver them. Yet they all remain bullish on the market, with projections for ASP sales still numbering in the billions this year. Perhaps Mark Twain said it best: Don't throw out a good idea just because the market isn't ripe yet.
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