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| Microsoft’s ASP Strategy Takes Shape |
| Aug. 28, 2000 |
The exploding application service provider (ASP) market has become a critical competitive arena for Microsoft. Actively courted by IBM, Oracle, and Sun, ASPs are excellent prospects for many of Microsoft’s latest products, such as Windows 2000 Datacenter, Application Center Server, and Exchange 2000, which are the first Microsoft products with the scalability and reliability that ASPs require. But the ASP model is not the endgame for Microsoft: that market poses many uncertainties for the company. Instead, Microsoft wants to move the industry "beyond the ASP" to its .NET platform, built around Microsoft’s traditional strength on the client desktop and its growing strength in server operating systems and Web-savvy database and collaboration tools. What ASP Means to Microsoft The application hosting business, in its current incarnation, is based on renting applications to users. The ASP hosts the applications on its own (or rented) servers, and the interface to the applications is thin-client software—typically a Web browser—on the user’s machine. Little or no special software is installed on the user’s computer, and the application runs primarily on the server’s CPU and in the server’s memory space. The ASP model promises companies lower software management costs, the option to rent software they could not afford to purchase, and rapid deployment of applications to their users’ desktops. It presents Microsoft with a mixed bag of threats and opportunities. Business and Technology Threats The threats include the following: Datacenter jitters. Microsoft’s server operating systems and collaborative applications such as Exchange have until now been optimal for workgroup or departmental service, but scaled poorly beyond a few hundred users. ASPs need systems that can handle thousands or even millions of users, with guaranteed levels of service and responsiveness. Microsoft is a relative newcomer to the world of 7x24 data centers and the 99.99% reliability that ASPs like to promise their customers. Competitors like IBM and Sun are well established in these areas. Operating system heresy. By putting the focus on network-delivered applications, ASPs reduce the importance of the desktop computer, its operating system, and any bundled applications, key sources of Microsoft’s market power. Unix and Linux servers can easily deliver a Java-based application’s interface to Windows-based computers, or to Internet appliances with non-Microsoft operating systems. Microsoft’s hard-earned dominance on the desktop offers only modest advantages in the ASP world. No more software launch parties. Rental software changes the economics of the software business. Clients pay by the month, rather than upgrading in a single purchase every 18 to 24 months. ASPs also promise to deliver the latest version of an application at no extra charge, eliminating the cost of—and revenue from—periodic upgrades (although upgrades are still necessary to maintain customer loyalty and generate continuing revenue). The shift—converting lump-sum revenues to monthly rents—can hurt revenues in the short term and spook investors. Picky clients. Microsoft’s current licensing models encourage large customers to purchase lots of software and distribute it widely across their organization, even if every user doesn’t use every program. The ASP model makes it possible for a company to rent exactly the software they need, when and where they need it. They can even reduce software costs immediately if they downsize, something difficult to do under Microsoft’s volume licensing programs. The ASP market also eliminates one of Microsoft’s most successful marketing tactics—bundling second-tier programs such as PowerPoint with first-tier programs like Word, to build the market share of the second-tier software. Cannibalization. Microsoft’s extraordinarily dominant and profitable Office suite of applications rules the business desktop. Delivering these applications as ASP services offers no advantage to Microsoft: companies that elect to rent Office will stop buying it. Indeed, ASPs commonly tout lower software costs as the most compelling argument for using an ASP. Microsoft likes to suggest that ASP-delivered Office is only for special cases (e.g., remote offices without IT resources), or that customers can supplement local applications with ASP-hosted versions at additional cost, but these arguments appear to limit network delivery of Microsoft desktop applications to either the desperate or the spendthrift. ASPs are hoping for a larger customer base than that and argue that hosted applications make sense for a broad segment of small and medium-size businesses. New Opportunities Microsoft’s concerns about application hosting do not appear to be having much impact on the ASP industry, whose growth projections are growing even faster than the so-far meager customer base. In 1999, International Data Corporation was predicting the application hosting business would hit US$2 billion by 2003. Mid-2000 estimates from Forrester Research and Gartner have boosted that prediction tenfold, putting the market at better than US$20 billion by the end of 2003. Dot-coms such as Digex, Exodus, and USInternetworking, not to mention long-established software players such as Oracle, PeopleSoft, and SAP, are rushing to build ASP offerings and services in the hope that customers will come. It is a market that, for all its potential problems, offers many near-term benefits for Microsoft. The opportunities include the following: Legacy-free start-ups. Microsoft’s new enterprise-capable offerings, such as Windows 2000 Advanced Server, Datacenter, and Applications Center Server, have the specifications that many new ASPs are looking for in terms of scalability, redundancy, and reliability. Just as important, a fully configured Intel-based server that runs these operating systems usually costs a fraction of a comparable Unix machine from Sun or IBM. That’s good news for start-ups, who need to preserve their capital, have no legacy systems in place, and need computer systems that can start small and scale up and out as the business grows. Stronger partners. Many of Microsoft’s most loyal partners, notably its Microsoft Certified Solutions Partners (MCSPs), see significant opportunities in taking custom applications and making them available to a wider audience over the Internet. Among Microsoft’s most loyal evangelists, these partners can now generate new revenue or deliver their applications more economically by going the ASP route. They are highly likely to use Windows DNA 2000 as the basis for hosted applications. A broader client base. Hugely successful with large organizations, Microsoft has had more trouble penetrating small businesses, which outnumber large organizations about 15 to 1. Small businesses tend to rely on low-end databases or spreadsheets for records management and use Simple Mail Transport Protocol (SMTP) mail servers, often hosted on Linux by their ISP, for e-mail—if they have e-mail. ASPs can offer small businesses and even some consumers inexpensive access to higher-quality software, such as Exchange and SQL Server. Shifting only a portion of the small business and consumer market to these more robust and flexible products could easily double the number of seats. Microsoft’s Strategy Given the mix of opportunities and threats in the ASP market, it is not surprising that Microsoft’s strategy has several components: aggressively building partnerships that will help promote its products; pushing hard to win deployment of its server operating systems and server applications; limiting deployment of its desktop applications by keeping prices relatively high, until it completes the "Web service" model of delivery; and maintaining control of the desktop clients, nudging them slowly to the more sophisticated clients of the future that its own application delivery strategy will demand. Competing for Partners Microsoft is aggressively encouraging MCSPs to become ASPs. They have the skills, the industry contacts, and often the existing custom applications based on Microsoft technology that could be offered for rent. When rolling out an ASP offering, these firms are highly likely to adopt Microsoft platforms, such as Microsoft’s Internet Information Server (IIS) Web server, Exchange, and SQL Server. In fact, any company that wants to be certified by Microsoft as an ASP for its products, or to offer Microsoft applications for rent, must be an MCSP. Microsoft is also making significant investments in ASPs and broadband providers, as well as signing co-marketing and technology sharing agreements with many others, to ensure that its products will be on the table when these firms make critical decisions about the platforms they will support and the services they will offer. In doing so, however, it is only keeping pace with the competition, some of whom are injecting massive amounts of money into Internet start-ups in an effort to win customers for their platforms for the future. So far in 2000 Sun has announced a US$300 million fund for start-ups, IBM US$500 million, Compaq US$1.15 billion, and Hewlett-Packard US$1.5 billion, which will provide financing, co-marketing, and other incentives for new Internet companies, many of which are budding ASPs. Competing for Servers Of those companies, only Compaq is likely to promote Microsoft’s software platforms in any significant way. Microsoft must compete aggressively for the ASP platform, encouraging use of advanced versions of Windows 2000 and of server applications such as BizTalk Server, Exchange, and SQL Server. The server systems that ASPs adopt determine what kinds of applications they can offer, and since Microsoft’s applications won’t run on Unix servers (while Oracle, for example, can run on not only Windows but Linux, MVS, OS/400, Unix, and others), any gains by IBM and Sun in the server market are not only platform wins but long-term application wins as well. By maintaining or increasing its market share on the server, Microsoft is building allegiances that will serve it well as it moves to a model in which software is delivered as a service. The systems that power ASPs today will power Microsoft-based "Web services" tomorrow. Caution for Applications While ASPs can drive significant revenues for Microsoft’s server products, the story is different for desktop applications. Switching these from its current licensing models to a rental business threatens Microsoft’s revenues. As the dominant player in the desktop business applications market, Microsoft has little to gain by "Web-enabling" its desktop applications—customers will merely shift their purchasing patterns, rather than spend more money on applications. Rather than risk its highly profitable packaged application software business on the ASP alternative, Microsoft has moved cautiously and has yet to signal serious plans to "Webize" Office applications as ActiveX controls or Java applets, for example. Office 10, recently released to beta testers, offers new features and improvements over Office 2000, but breaks no new ground in terms of ASP hosting. Instead, Microsoft’s "Office Online" initiative relies on existing technologies—the current versions of Office accessed via Terminal Services rather than via an Internet browser. Terminal Services is actually old technology, available on Unix for more than 20 years and on Windows NT for at least three. Terminal Services let an application run on a server that receives input from, and displays its output on a separate client machine or terminal, such as a PC. The application runs on the server’s CPU and in its memory, but is viewed and controlled from the PC. In Microsoft’s case, it offers a serendipitous set of advantages:
Microsoft has also set prices for Office Online high enough to discourage defections from its current licensing programs to the ASP alternative. Although companies may want to use an ASP for other reasons, relatively few will save money simply by purchasing Office from an ASP. Bypass Commodity Browsers Although the ASP model emphasizes the server—it actually runs the application, rather than the client PC—the browser remains a critical piece of the delivery system. A recent survey by Windows 2000 Magazine found that half of ASP clients wanted applications that ran in a browser, while less than one-third wanted Windows applications that used Terminal Services, for example. Because Microsoft owns the browser market—more than 85% of the browser traffic on the Internet is some version of Internet Explorer (IE)—it is in an excellent position to employ a classic Microsoft strategy, "embrace and extend," to create a Microsoft-centric client that works especially well with Microsoft server products. For now, that remains more a potential strategy than an operative one, but Microsoft is clearly prepared to move beyond slow-moving standards bodies and commodity browsers to create "rich" clients that exploit and promote Microsoft technologies. In summer 2000, Microsoft released a new MSN client designed to enhance the "Internet user experience" with integrated support for audio and video, the ability to personalize the default content that appears in the client, and that offers a simplified interface. It could be the basis for further experiments with client software that paints outside the lines of conventional browser technology. Even with its standard browser, IE, Microsoft is prepared to follow proprietary paths. As a document outlining the features of IE 5.5 puts it, "As we move forward with future releases of Internet Explorer, we will again evaluate which standards will be supported to offer developers a great platform for development." Beyond the ASP The goal of Microsoft’s strategy has sometimes been described by Microsoft executives as "beyond the ASP." Microsoft’s vision for the "third-generation" Internet envisions "federations" of Internet-based servers that deliver "software as a service." Unlike current ASP offerings, which generally rely on standard Web servers that deliver the full HTML to a browser that renders the result, Microsoft’s software-as-a-service is more complex. The services may in some cases be applications, but in many cases they will be "building blocks," highly granular application components that can be used by multiple applications and that can provide services and data fragments to multiple devices through multiple interfaces. These servers will in many cases be only partially visible to end users and will offer their services (via XML and other communications technologies) to other Web servers or Web sites. A current example is Microsoft’s Passport service, which manages user credentials for Hotmail, MSN, and for Microsoft’s own Web-based product support services. As a way to deliver Microsoft’s applications, such as its desktop applications, over the Internet, this model has several advantages for Microsoft over the current ASP model. Ownership of the applications. Microsoft has indicated that future federations of Web services will include both Microsoft-owned and third-party-owned services. This raises the likelihood that Microsoft may itself offer Web services directly to consumers, as well as through other companies that aggregate selected services for sale to end users. Support for new devices. As the PC market hits a plateau, demand for portable and handheld devices is exploding. Microsoft needs to create products that will function in a wireless, portable future. Delivering software as networked services, which can adapt to the capabilities of the user’s device, is a feasible way to migrate Microsoft’s Office franchise to these new devices. New services and revenue. In a network-centric world, demands for bandwidth, network storage, and security services are skyrocketing. All represent substantial revenue opportunities for Microsoft and its allied partners. Demand for capable clients. Client-server networks have always required careful balancing of the workload between the client and the server. "Thin" clients require fat servers and fat network pipes. Thick clients can reduce network traffic and server loads but require faster processors and more memory on the client. Demand for more interactive Internet services and streaming media will raise the bar for clients that work seamlessly with servers. Handheld devices of the future will have more memory and CPU horsepower than those of today and, in Microsoft’s .NET vision, will have capabilities carefully tailored to access and deliver content or services from servers on the Internet. As the world’s premier client software company, Microsoft is in a position to dictate much of that development in ways that match its .NET plans. Recent Steps Microsoft has officially endorsed the current ASP market with the release in July of new licensing terms for ASPs who want to rent out Microsoft software and the announcement of a new certification program for ASPs who meet very high Microsoft standards for service. Licensing Beginning in 1999, Microsoft reexamined its licensing policies in light of the ASP phenomenon and found that its licensing programs were often a poor fit. Its Commercial Licensing program, for example, which permits companies to provide Microsoft-based software services without requiring the end customer to have a software license from Microsoft, forbade rental arrangements, and no model was in place to rent packaged applications such as Office. A lengthy pilot program, beginning in Oct. 1999, helped Microsoft and ASPs learn more about demand for online applications, gain a sense of what pricing levels and terms were acceptable, and refine the delivery of Office using Terminal Services. Under an ASP licensing plan that it announced to its partners on Aug. 1, 2000, Microsoft will license Office, SQL Server, Exchange, and Commerce Server, as well as Windows 2000 Server and Advanced Server, for use by ASPs. Depending on the product, ASPs can license the product on a per-user basis (to a named user, who can access any number of servers from any number of devices); on a per-CPU basis (available to any number of users); or both. For more information, see the sidebar "ASP Licensing Terms". Certification To encourage high standards among ASPs who offer its program for rent, Microsoft has announced the ASP Hosting Certification Program. The program sets a high bar, however, and Microsoft itself estimates that only about 100 firms are likely to qualify in the next year or more. Among other things, Microsoft-certified ASPs must be MCSPs. They must have a Microsoft Commercial License and must already have customers in place. In addition, they must maintain sophisticated management processes for billing, service level monitoring, provisioning services, software upgrades and patches, and must maintain an advanced help desk of their own in addition to having a premier support agreement with Microsoft. Investments and Partnerships Microsoft expects only the largest and most advanced ASPs to qualify for this certification, and not surprisingly, it has inked agreements or even made outright investments in many of these firms, such as Concentric, Data Return, Digex, Interliant, NaviSite, Qwest, and USInternetworking. A typical equity investment was US$12 million put into FirstWorld, a Denver, CO-based ASP. Microsoft earlier invested in Corio and Digex, two large ASPs. Other steps that Microsoft has taken to ensure that its products grow with the ASP market include giving away copies of its server software, European "solution hotels," and partnerships with major consulting firms. Windows 2000 Service Provider Early Adopter Program. This program offers a free copy of Windows 2000 Advanced Server to eligible service providers in the United States (who must display Microsoft logos on their site, among other things). The program also provides discounted training and support from Microsoft partners. Co-marketing and strategic alliances. Microsoft will offer e-commerce solutions in the Latin American market with KPMG and Canadian ASP Pivotal; will create "solution hotels," (data centers in which ISVs can rent server space and bandwidth to offer hosted applications) with Compaq and European broadband provider FirstMark; and will work with a US$1 billion joint venture formed by telecommunications giant Cable & Wireless Plc and Compaq to offer application hosting services in Europe, North America, and Asia. Preconfigured ASP solutions. Working with Dell, Hewlett-Packard, and other server vendors, Microsoft is developing marketing programs and preconfigured hardware, such as HP’s "SP-in-a-Box," an HP NetServer loaded with Windows NT Server and Windows 2000, as well as Microsoft e-commerce software. Facing the Future Microsoft’s strategy appears to give the company considerable traction in the ASP market, but competition is intense and other risks must be avoided. Competition from Sun. Arch-competitor Sun, for example, works with most of the leading ASPs, including many that also work with Microsoft. While Microsoft’s certification program has as yet no named participants and is still barely more than a draft (to judge by the crudely written white paper on Microsoft’s application hosting Web site), Sun has more than 300 participants in its analogous SunTone Certification Program. Critical software releases. The fall of 2000 will give service providers their first look at crucial Microsoft server and server application software, such as BizTalk, SQL Server 2000, Exchange 2000, Applications Center, and Windows 2000 Datacenter. Any stumbles on Microsoft’s part in releasing robust and scalable products could prompt ASPs to look elsewhere for products that can fulfill their business plans. Web services delays. Microsoft’s plans for "federations" of Internet servers that provide "software as a service," as outlined in its .NET program, may already be an old idea—even though it is a year or more from release. The dynamic ASP market is already spawning services that aim to transparently aggregate Web services provided by others, targeting primarily the small business market. A new class of business service providers (BSPs), for example, offers suites of hosted applications from different vendors, not unlike the way that servers from different service vendors will cooperate in a .NET scenario. Although the execution of this plan may be different from Microsoft’s vision, its appeal to customers might be similar—with the difference being that BSPs offer it today. (For more information about the structure of the ASP market, see the sidebar "What Is an ASP?".) Pricing vulnerabilities. Microsoft’s efforts to maintain revenues by setting rental fees, particularly for Office, at a point where the ASP model offers no price advantage to most customers poses a risk both for Microsoft and for ASPs. It may maintain Microsoft’s current revenues, but it will do little to grow them and gives ASPs little to offer customers. An ASP may be valuable for hosting a technically demanding application like Exchange or SQL Server, but most offices can manage an Office installation themselves. Office Online pricing also leaves a large market opening for Sun, whose Office-compatible Star Office suite will be available to ASPs for free. Resources An extensive list of white papers, case studies, licensing materials, and other documents can be found at Microsoft’s application hosting site, www.microsoft.com/apphosting/. More information about the new MSN client is available at http://preview.msn.com. A list of Microsoft investments is available at www.microsoft.com/msft/invest.htm. For more information about Terminal Services, see "Terminal Services Moves into the Mainstream" on page 3 of the Mar. 2000 Update. |
