What happened to the application service provider (ASP) marketplace? In 1999, IT analysts at International Data Corporation (IDC) predicted a worldwide ASP market worth $16 billion in 2002, and Forrester expected $21 billion by 2001. Gartner Dataquest forecasted that the worldwide ASP market would reach $22.7 billion by 2003. In reality, the total ASP market accounted for a paltry $300 million in 1999, and by 2000, some of the largest entrants, such as the SAP/Intel joint venture, Pandesic, were calling it quits, while others, such as USInternetworking, were losing hundreds of millions of dollars. IDC has since scaled its 2002 revenue estimate for the ASP industry back to $2.4 billion. The Gartner Group has predicted that of the 500 ASPs spun out in the last few years, only about 60 will remain by 2002. According to some Silicon Valley wise guys, the acronym ASP now stands for “Anyone Still Paying?” Are the ASPs simply victims of the Internet bubble and the general downturn, or did they have some intrinsic flaws that made them especially vulnerable? Now that the very letters ASP are comedy material, are there any viable business models in the outsourced application space?

In this article, I’ll discuss the apparent downfall of the ASP model and the vertical service provider (VSP) phoenix that is currently rising from the ASP ashes.

Adapting a problematic business model
From the beginning, there were doubters of the ASP gospel, citing the difficulty of the “one-app-fits-all” idea, and the challenge of differentiating an “apps-on-tap” business. Security concerns, the need for customized apps, and the difficulty making a profit in an expensive, service-intensive business—all of these factors bolstered ASP nonbelievers. The demise of dot-com customers was another confirmation of the ASP’s vulnerability. Many ASPs saw huge revenue projections dissipate as their start-up clients ran out of money and blew away. Pandesic, in its swan song, hit on the crux of the ASP’s difficulties; they cited “slower than anticipated market acceptance” and “no path to profitability.” That deadly combination, combined with the gloomy environment that followed the bursting of the Internet bubble, has created an aura of skepticism around the ASP concept.

Still, many investors, analysts, and entrepreneurs believe that, as in many areas of the Internet, some unique and valuable companies will eventually crawl from the wreckage of the ASP market. In a perceptive report published by investment analysis firm Cherry Tree and Co., the lessons learned from the ASP rookie years are clearly stated: “Today, the proposition of merely offering hosted applications does not pull much weight with customers, analysts, or investors.” The report goes on to state that ”The companies that are building sustainable ASP business models are offering far more than hosted applications. Additional value-added components need to be offered in order to build long-term, strategic relationships with customers.”

What are these value-added elements? For many investors and entrepreneurs, the answer is vertical focus. Crosspoint Venture Partners of Woodland, CA, recently rated as the most successful venture capital firm in the world by Forbes magazine, believes in the VSP model. They’ve invested in fourteen VSPs, including ventures that provide services to industries as varied as mortgage lenders and restaurants. Here’s what Crosspoint says on their Web site about the VSP market: “Vertical Service Providers combine Internet technology with deep domain expertise, industry-specific applications, and content in branded, integrated solutions delivered as a service over broadband and the Internet.”

The added value of VSPs
Let’s analyze this definition to get a picture of the differences between an ASP and a VSP. The ASP concept is simple: Serve applications over a network. ASPs provide access to application packages on a per-use or rental basis. This model took off when the standard protocols of the Internet, and the standardized Web browser, finally offered universal network access and a standard client interface. These providers of packaged applications, now pejoratively called generic application service providers (GASPs), offer software that has broad functionality across a range of businesses. ASPs develop economies of scale by selling the same application, served from the same technical infrastructure, to many clients. Inherent in this business model is the tension between the provider’s need to keep the infrastructure generic and so build economies of scale and the client’s desire for an application specifically tailored to her needs.

The VSP, rather than aiming for wide use of a generic application, aims to provide deep functionality to a specific industry. More than just an ASP for a vertical, VSPs have developed past the ASP model to become a vertical service broker, adding additional IT applications as well as other types of outsourced business services. This can include back-office services such as, for example, credit card verification and linen handling in the restaurant industry, or parts handling and supply chain management in the electronics manufacturing business. The VSPs, by selecting and integrating some core vertical applications, then adding some service relationships and other industry-specific bundled services, are creating a model that leverages the Internet but also integrates other off-Net services into an industry-specific outsourced solution.

Great expectations
It’s not just Crosspoint Venture Partners, with its big bet on this market space, who is enthusiastic about this market; other analysts believe they see a trend here as well. According to Michael Sherrick, Application Services senior analyst at Morgan Stanley, “VSPs represent a new breed of service providers with the opportunity to generate rapid growth and high margin. We expect many VSPs will emerge as industry platforms addressing both the B2C and B2B needs of their clients.” Lew Hollerbach, an analyst at Aberdeen Group Inc. in Boston, agrees that the service provider market is going vertical. “The lion’s share of ASP activity to date is happening in the vertical market space,” he recently stated. “It makes sense to be specialized. ASPs in a particular market already know what their customers need and can add additional services.” Rich Shapero, Managing Partner of Crosspoint, goes even further. “We think these early VSPs could really be a substantiation of a sea change in IT. We may look back 20 years from now and say the biggest impact of inexpensive broadband and the Internet has been to revolutionize IT and the way it’s delivered.”

Share your war stories

Has the ASP model worked for your organization? How has the emergence of the VSP concept affected your industry? Compare your real-world experiences with the trends described in Rick Freedman’s article. Does your experience challenge or confirm the developments he mentions? Share your thoughts by sending an e-mail or posting a comment below.