VCs in love: VSP market proves alluring

The emergence of the vertical application provider (VSP) has lots of analysts and investors excited. Find out what the buzz is about and where the VSP marketplace is headed.

While the application service provider (ASP) space has faltered, many analysts are optimistic about the emergence of the vertical service provider (VSP) market. In this article, we’ll take a look at the VSP strategy and the diversity of activity it has spawned, and we'll gather some opinions about the viability and future of the VSP model.

Exactly what qualifies as a VSP?
The buzz around the vertical service provider (VSP) phenomenon makes it seem as if there’s a coherent business model behind the VSP concept. In execution, however, these companies differ greatly. Companies identified as VSPs range from Voxeo, targeting the Web-to-phone service provider market, to Vital Link, servicing the restaurant and nightclub industry, to RedSpark, a San Francisco-based AutoCad spin-off that focuses on Internet-enabling the supply chains of high-tech manufacturers.

These companies target different markets, but their dissimilarities don’t end there. The fundamental business concepts and offerings of these enterprises are all over the map as well. While RedSpark functions like a vertically focused ASP, serving up its specialized application to a tightly targeted industry base, MyAssociation of Salt Lake City offers a broad range of technology advisory services, including Web site design.

In some cases, the VSP label seems a stretch—how do you call SanRise, a dealer in Internet-accessible outsourced data storage, anything but an infrastructure outsourcer? Others, like eSilicon, seem to exemplify the VSP trend, with proprietary technology served up in a hosted model, bundled with services such as contract design, engineering, and testing, targeted at their specific vertical market—integrated chip manufacturers.

How it’s done: Industry expertise is key
Dominic Gallelo, RedSpark’s CEO and a former AutoCad International EVP, thinks RedSpark’s value proposition is obvious. “We differentiate ourselves by our deep industry expertise…when we talk to the end user or the supplier management people; they love what we’re building.” When I asked him how RedSpark gets past the standard objections about security and flexibility, he explained, “When we talk them through how we do security, they realize that security is so critical for us that we can throw a lot more at the problem.” He also explained that the only application customization RedSpark supports runs on the client side, never in RedSpark’s hosted server apps. “We’ve architected an environment that is highly configurable and customizable by the customer, based on forms or servlets on the client side. If we have to do that customization on the server side, we’re dead.” Rich Shapero, Managing Partner of Crosspoint Venture Partners, emphasized this point. “They all understand that the unfair advantage the VSPs have is that, focusing on a vertical, you have the opportunity to create a specialized solution and avoid a lot of customization. They've all tried to create solutions that were general enough to appeal to the vertical yet specialized enough to eliminate customization.”

Rich Hanks, CEO of MyAssociation, the VSP that aims to be “the trusted technology advisor” to associations and affinity groups, agrees that domain experience is the differentiator. “We’re not a bunch of dot-com guys in Palo Alto who decided to go tap an untapped market. We have 350 years of combined association experience. Our executives have been presidents of various associations.” Hanks also stressed the difference between the VSP and the ASP. “When you have an ASP who is really just a broker of someone else’s software, their margins aren’t good; the loyalty to them is zero. When people buy from us, they’re going to where they can trust someone. You can call it a VSP or you can call it a one-stop shop.”

The new opportunity defined
Shapero explained the genesis of this leading VC firm’s interest in the VSP concept. “We started off investing in outsourced business services, because we thought that the intersection of broadband and the Internet provided the enabler. The most obvious way of doing that was to take applications and run them on a server, so you have hosted application service providers. We never were very excited about that model because you don’t have any kind of staying power with the customer.”

Shapero described the evolution of these VSP businesses: “There’s a three-step evolution a lot of these companies are going through. The first step is identification of one or a few enabling applications for a vertical. The second tier is a lot more elaborate; it’s offering many vertical applications instead of one. At that level of richness, it’s a different value proposition to the customer. The third tier is really that participation in the supply chain. Here, the VSP completely breaks out of the 'apps-on-tap' hosted model.”

As Michael Sherrick of Morgan Stanley noted, there’s an opportunity for VSPs to take over some of the functions of the B2B exchanges that were the rage last year. In fact, this development seems to be the endgame visualized by many of the players. Shapero, for instance, stated, “It seems to naturally evolve. At some point, they become part of the transaction stream. They become a buying collective, or a buyer agent, for either the buy side or the sell side. I’d compare VSPs favorably to the Net marketplace exchanges.”

Forecast: Partly risky followed by sunny profits
With all this positive exposure, you’d think that the success of the VSP business model is a foregone conclusion. But all the players realize that there are obstacles. Gallelo said that there are still significant client objections to overcome. “[The] customer’s concerns are around security, around “Can I customize it?,” and around “How do I integrate it all and migrate the data to my production system?”

The complexity of executing a business plan that calls for multiple hosted applications and service relationships, and vertical domain expertise is also an issue. Shapero noted: “This business will be enormously complex; we’re seeing that. Can they get too complex and create an execution risk? The answer is yes. The good news is that the relationships are so close that if you have a customer satisfaction issue, you know it.” Shapero also recognized the importance to VSPs of developing a complete offering quickly. “Those that don’t progress rapidly to increased functionality will be behind the eight ball competitively,” Shapero stated. “Speed and richness of functionality are going to become increasingly important as competition surfaces.”

Has the ASP marketplace morphed into a market of vertically focused providers that combine Web and off-Net components to create compelling offerings for their target markets? It’s too soon to tell, but it seems clear that going vertical is one of the strategies ASPs are considering in their bid to survive the dot-com meltdown.

What’s the VSP profile in your industry?
Which VSPs serve your sector? Have you had experience with any of them? Or, if you work for a VSP, share your experiences with TechRepublic. Post a comment below.


About Rick Freedman

Rick Freedman is the author of three books on IT consulting, including "The IT Consultant." Rick is an independent consultant and trainer, working, through his company Consulting Strategies Inc., to help agile teams and organizations understand agile...

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