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Enterprise Resource Planning Systems (ERPs) and Application Service Providers (ASPs) dominate today's business news headlines. In a market that was considered saturated, ERP vendors have dramatically broken new ground. The result is a lucrative bonanza for the ASPs. The stimulus of this developing market boom and its strategic importance is similar to the historic account of the Panama Canal.

Because of the influx of settlers in California and Nevada after the 1840's Gold Rush, a means of transporting freight and people to those areas became the focus of businesses. Traveling over the mountainous regions by railroad was slow and dependent on weather conditions; it was also risky because of poor maintenance of the rail tracks and cars. By far, the best way to transport freight and people was by water. But, prior to the Panama Canal's construction, the only way to travel by water from the Atlantic coast to the Pacific Coast was to go south, passing Central America, around the southernmost tip of South America; turn north through the Pacific Ocean, veering westward past Central America, on to the Pacific Coast of the United States. The journey was long, arduous, and expensive. It was also risky around the cape at the southern end of South America, where ships met with dangerously strong winds and currents.

To construct a faster, less dangerous and less expensive route, the U.S. leased land from the Republic of Panama, an isthmus through the Caribbean Sea between Central and South America.

On the leased land, U.S. military engineers built the canal, and the first American ship passed through its waterway in June of 1914. The canal completely changed the way business was conducted from coast to coast in the U.S.

Breaking New Ground

Enterprise resource planning systems (ERPs) are client-server software applications, or systems, that most large companies today use to organize and conduct their businesses. In today's competitive environment, ERP applications offer the solution of increasing the speed of transactions andminformation flow. Software vendors that sell ERP applications have becomemsome of the best-known names in the IT world--SAP, PeopleSoft, J.D. Edwards & Co., and Baan Co.

Until recently, the market for ERP applications has been only mega companies. Although midsize companies (with annual sales of $20 million to $500 million) also need ERP applications, the expense has been prohibitive. To run an ERP package, it takes a greater level of infrastructure for networks, which are expensive to buy. With, for example, costs of $300,000 on the infrastructure, another $300,000-$400,000 on the software, and then more than a million dollars on the implementation, companies are asked to make a very stout and significant investment. Midsize companies have been reluctant to do this.

The remedy has come through the Internet and ASPs, and suppliers have opened the market for midsize companies, without necessitating the enormous investment. With the mega-companies market being saturated, and a means of making ERPs affordable and accessible to midsize companies, vendors have turned their attention to the vast, untapped midsize market. Thus, there is a huge boom in the marketplace again for ERPs.

The Role of ASPs

Application Service Providers (ASPs) are outsourcing companies that rent packaged, ERP application solutions that have been licensed from a software vendor; provide remote access to them via the Internet; and provide bundled support services along with the application services. The ASP runs many companies' applications through its own centralized IT facility, rather than providing equipment and services at the customers' sites. Pricing varies widely among ASPs. Some provide services for a flat fee; others on an as-needed basis. Some charge an installation fee. Some price on a per-user, or per-seat basis. In this issue of OutsourcingJournal, analyst, Michael Corbett, explains the need to understand the options and to select a strategy that supports future growth and flexibility.

The ASPs significantly reduce the cost of the investment for a midsize company to access the sophisticated technology. The ASP already has invested in the infrastructure; has a preconfigured environment, which is less costly to implement; and it has the expertise and IT staff to implement and maintain the services. It is an ideal, out-of-the-box solution for midsize and small companies, which usually have limited IT staffs and tight budgets. ERP can help these companies in reengineering how they conduct business and can even help to expand business. The economies of scale presented by the ASP solution create enormous value and allow outsourcing to do what it is supposed to do-free the buyer to focus on its core business. David Blumhorst, director of IT at Clarent Corp. (a high-growth, midsize company) explains in this issue how these factors figured into the company's selection of an ASP.

Let the Buyer Beware

The value proposition for buyers accessing ERPs through ASPs is profound. But there will be trade-offs. Whereas large companies require customization, suppliers have found that ERP is easier to implement in mid-market companies because they are willing to adjust. The result is that suppliers are coming to midsize buyers with a turnkey approach, limiting the buyer's ability to customize the program. One of the significant elements is a trap for the buyers. Suppliers are coming in with prepackaged contracts, which are very much stacked in the suppliers' favor. The whole relationship is then set up to be very advantageous to the supplier. In this issue, Bill Deckelman, an attorney with the Munsch Hardt law firm, explains some of the legal and contractual blunders that can occur in these deals.

Buyers need to reduce their transaction costs to get into such a relationship, of course; nevertheless, buyer need to be very careful before they sign one of these out-of-the-box deals. This is particularly important with the big outsourcing suppliers that have a tendency to bring their win-lose practices to this field. Basically, these deals are not different from other types of outsourcing. Buyers still need to apply discipline. They still need to precisely define what they are buying, how to measure the results; and they still need to effectively manage the relationship.

What the Future Holds

From the suppliers' perspective, this new midsize market is potentially very lucrative because of the leverage points. The ASPs will be leveraging everything (application support, the network, and the hardware), and economies of scale in relatively small transactions mean significant profit. It's rather like the beginning of the Internet-the ASP market looks to be very lucrative, very quickly.

We are right at the beginning of the new ERP market, and there is an enormous investment in R&D going on to establish new ASPs. The venture capitalists are pouring in. At Everest, a new ASP being brought into line is contacting us nearly every day. Furthermore, every major outsourcer (companies like EDS and Origin) is attempting to get into this potentially extremely lucrative market.

We look for many mergers and acquisitions--strategic alliances to strengthen the ASPs. Corio, Inc. (the leading ASP), for example, has recently entered a strategic partnership with PeopleSoft, making Corio the preferred ASP partner for PeopleSoft. Walter Lazuka, president of CorpCare, explains in this issue how ERPs and ASPs facilitate the best-of-breed approach.

The ASP Industry Consortium was formed in May 1999 to foster research, establish technical specifications and best practices among ASPs. There is already an online catalogue (AppsOnline) of rentable web applications. The ERP/ASP industry is expanding at a rapid rate.

The extreme rush to get into this market is part of the downside. At this point, it is an immature market and is populated with start-up companies. It faces security issues, service-level issues, how extensively an application can be altered, and how well the new ASPs understand the industries and business of their potential new customers. To match this new market, I think we are going to see independent, third parties (such as Everest, for example), providing objective contracts, service descriptions and service level metrics that keep the transaction costs low but that give buyers the opportunity to negotiate from a level playing field. We, at OutsourcingJournal, will keep an eye on the ASPs and keep you informed as to new developments in the ERP marketplace

Publish Date: October 1999

Copyright © 1999 - Everest Partners, L.P.

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