Only a couple of years ago, the idea of renting enterprise software seemed downright radical. Even so, given the potential benefits -- sidestepping the labor shortage in information technology, not having to worry about keeping up with each and every new technology, and avoiding a major investment in IT infrastructure -- the new application service provider (ASP) model looked enticing to Edward Wolff. As director of human resources for Internet service provider Earthlink Inc., Atlanta, Wolff decided to give it a try. "Outsourcing," he explains, "allows a company to take advantage of efficiencies that aren't possible internally." Under the new setup, virtually all HR functions at Earthlink, which has 5,800 employees, are managed off-site. When employees update their records or sign up for a medical plan or 401(k), they enter the data from a PC at Earthlink or at home and it is sent immediately to Atlanta-based application service provider Employease Inc. Earthlink, the second largest Internet service provider (behind America Online Inc.) with about 3.5 million customers, owns the data but never touches it. "When we first turned to the ASP model in November 1998, we weren't sure how well it would work. There has been a lot of hype and attention devoted to the subject," says Wolff. "Fortunately, it has turned out to be a viable business model." The number of companies using ASP services has increased from near zero a year ago to 7.3% in early 2000, according to a survey conducted by [email protected] Week magazine. And the ASP market is expected to grow to $7.8 billion in 2004, compared with $296 million last year, based on figures from International Data Corp., an IT research firm in Framingham, Mass. Adds Daniel Sholler, a senior program director at Meta Group Inc., a Stamford, Conn., IT consulting firm, "We are starting to see significant adoption of the ASP model within certain market niches." "Early on, the hype far exceeded the reality," says David Caruso, vice president of enterprise applications strategies at AMR Research Inc., Boston. "Now, a couple of years later, ASPs are becoming reality." But not for everyone. Dot.com start-ups with no IT staff and virtually no technology infrastructure may find ASPs to be a quick and dirty way to acquire applications -- particularly core packages such as enterprise resource planning (ERP) and customer relationship management (CRM). But most large corporations aren't ready to replace their existing IT staff and previously installed ERP systems with this new concept. More likely, some are considering using ASPs as a way to automate non-mission-critical areas such as travel and expense reporting and employee benefits enrollment. While traditional software can require months or years to install, ASP software typically takes weeks, and sometimes days. Vicki Griffith, director of netsourcing at Lawson Software, St. Paul, says that by moving important but underutilized applications to an ASP model, business managers are able to bring new functions and features to constituents. They're also able to predict costs far more accurately and budget far more predictably. "It is helping companies view IT as a strategic enabler rather than an expense." Not surprisingly, the list of ASP vendors and applications is growing rapidly. Recently, the likes of SAP AG, PeopleSoft Inc., Oracle Corp., J.D. Edwards & Co., and Lawson Software have elbowed their way into the market. So, too, have a seemingly endless wave of second- and third-tier players offering everything from content delivery to Internet security systems to time and attendance tracking. At the same time, independent ASPs like USinternetworking Inc. (USi), Corio Inc., Breakaway Solutions Inc., Qwest Cyber.Solutions, and AristaSoft Corp. have begun to offer an array of enterprise applications as well as integration expertise. They can help meld ERP, CRM, accounting, supply-chain management, logistics, and data-warehousing software into a larger integrated solution. "Technological enhancements along with the growing reliability of the Internet have made the ASP far more attractive," says Mike Harper, a business unit president at USi. Many ASPs also are targeting their products to specific vertical markets. "At first it was enough to offer a basic ERP or CRM package. Now the emphasis is on ASP products optimized for the utility industry or the pharmaceutical business," says Sholler. Of course, the advantage to this approach is that it allows companies to use applications that are more closely adapted to their needs without having to go to the time and extra expense involved in customizing the software. For example, Vertical Networks Inc., a Sunnyvale, Calif., manufacturer of integrated voice and data network systems, has created a virtual IT department by outsourcing an array of applications, including PeopleSoft and Siebel eSales, to Corio. Finance director Virender Ahluwalia says that the strategy has allowed the company to seamlessly integrate these solutions to Vertical Networks' manufacturing applications, thereby streamlining business process capabilities in a big way. The proof is in the numbers. Initially, Vertical Networks estimated that an in-house ERP application would cost $1 million to $2 million. More importantly, the company didn't have a year or two to deploy the application. After selecting Corio it managed to have the systems up and running within 10 weeks. Ahluwalia estimates that the move to an ASP provided a 60% reduction in total cost of ownership, which translates to an upfront gain of $2.4 million. Moreover, Vertical Networks estimates that it will achieve a return on investment of about 170% over a five-year period. According to analyst Laurie McCabe, vice president of consulting firm Summit Strategies Inc., Boston, many firms are beginning to recognize that the ASP model provides a powerful way to defer capital costs. "You don't have to go out and buy hardware, software, and networking gear. You don't have to hire IT staff and worry about upgrades, security, and system performance." Of course, deferring costs doesn't eliminate them. The monthly rental fee for major ERP packages, for example, has settled into the $400 to $1,000 per seat range, after setup. Other applications now range from $10 to $100 per month per user. However, overall cost often isn't the primary factor -- or sometimes even a significant factor -- in the migration toward ASPs. Time to market, the need to focus on core competencies, and the desire to reduce the risk of dead-end technology all play a role. There's also the fact that ASPs allow an enterprise to quickly and easily scale up the number of users. "What organizations buy when they adopt an ASP business model is not just an application and hosting, but access to IT expertise," explains Sholler. For many firms, that now translates into an ASP playing a key role in choosing and implementing applications, and configuring, operating, and upgrading them. "In the past, small organizations did not have the wherewithal to get these people," adds Sholler. Likewise, large companies that find themselves maxed out with IT resources, or that need to start a new division or spin off a new firm, can find instant applications a boon. What's more, if the new business venture fails, they aren't left holding expensive servers and software. Take Sunburst Hospitality Corp., Silver Spring, Md., a 1997 spinoff from Choice Hotels International that was left to navigate the brave new world of information technology pretty much on its own. The firm, which operates Clarion Hotels, MainStay Suites, Comfort Inns, and Comfort Suites, knew that it needed leading-edge enterprise software, yet it couldn't wait months for consultants and internal staff to plod through an arduous planning and implementation process. It also couldn't watch money and manpower disappear into a black hole, says Chuck Warczak, vice president of financial systems. The solution? Rent enterprise software rather than buy it. In early 1999 Sunburst turned to USinternetworking for PeopleSoft accounts-payable, general-ledger, and fixed-asset modules, and had them running within weeks --- all without hiring new IT staff, investing in systems, and adding to its corporate overhead. When the parent firm, Choice Hotels, installed the same software a few years before, the project had taken two years and drained millions of dollars from the corporate coffers. "We're in a dynamic industry and subject to a lot of cyclical phases. The ASP approach simplifies things greatly," says Warczak. Deepak Gupta, senior vice president of PeopleSoft Inc.'s eCenter, believes that 1999 was the year the concept found its way into the factories and offices of early adopters. This year, he says, is when "proof of concept" will take place. And he predicts that by 2001 ASPs will become a mainstream phenomenon, attracting numerous middle-market and small companies that never before have had top-tier systems in place. Yet, despite rosy predictions and numerous success stories, the ASP model is far from flawless. For one thing, some companies that have turned to application service providers have found that performance isn't up to par. Caruso says that ASPs operating huge server farms sometimes aren't able to pinpoint specific performance problems. Others simply "don't have the skills to do what they say they can do." In addition, the connection between a company and the ASP is only as good as the telecommunications link. Customer service has turned out to be an even bigger headache. [email protected] Week's survey found that ASPs ranked dead last in customer approval ratings, behind dedicated Web hosting companies, consulting firms, software systems integrators, and Internet access firms. According to Sholler, "The ability of ASPs to offer service-level agreements is growing, but most ASP vendors are still lacking in this regard. That means that the only recourse for customers is . . . saying you're not going to pay, at which point you could find essential services and capabilities shut off." In fact, he insists that within the current market many providers are not able to offer service guarantees because they suffer from the same IT labor shortage that has befallen other companies. Despite offering stock options and higher pay, they find it a daunting task to attract and retain top-notch IT talent. What's more, the complexity of the systems requires constant monitoring and attention, something that can vary greatly from one application service provider to another. Ultimately, says Sholler, it is essential to insist on an agreement that specifies service levels for availability, downtime, constraints, bug fixes, security, response time, and more, as well as compensation when things go wrong. The challenges often become more daunting as companies attempt to integrate ASP applications. Although certain ASPs can tie together an increasing mlange of applications, things can get extremely tricky as multiple application service providers and software packages enter the picture. "There are technical issues, performance issues, and cost issues," states Summit Strategies' McCabe. She says that the biggest problems occur when companies begin customizing code at the source level rather than at the presentation layer. "That can lead organizations down a huge rat hole" and eventually torpedo a project as endless tweaks and adjustments take place. Then there's pricing. It's no secret that ASPs have engaged in opportunistic pricing schemes in order to grab business and market share. Whether prices will remain low remains to be seen, especially as the industry consolidates over the next couple of years. "The fact is, ASPs are operating under the assumption that economies of scale will make them profitable -- and that intuitively makes sense -- but so far nobody fully understands the economics of the situation and whether the business can be profitable and sustainable," says Sholler. Consider: USinternetworking tallied a net loss of $39.6 million in the first quarter of 2000 despite a 12-month backlog of business valued at $62.4 million. Indeed, some analysts are beginning to curtail their enthusiasm for the ASP concept. Market research firm Dataquest recently scaled back its growth predictions for the ASP market by nearly 30%. Meanwhile, many leading industrial firms considered using an ASP but decided against it. In some cases the economics didn't make sense, particularly for companies that already have a large IT staff. In other instances ASPs couldn't handle the complex real-world needs of a company that might require a full spectrum of integrated solutions. Even so, new ASP offerings keep entering the pipeline. Spatial Technology Inc., a Boulder, Colo.-based software manufacturer, recently launched a Web-hosted application portal that lets design engineers work and share 3-D data files across multiple platforms. Atlanta-based Internet Security Systems Inc. now offers its security management solutions on a remotely managed basis. AppStream Inc., a Palo Alto, Calif., company, hopes to ratchet everything up a notch with new technology that will deliver only the parts of an application that a user needs, thus lowering costs and improving system performance. Make no mistake, application service providers already are altering the landscape and changing the way companies use and view technology. As hosting and outsourcing pick up more steam, it's clear that the role of ASPs will grow. Says Andy Bartels, a senior research analyst at Giga Information Group Inc., "As networks become more sophisticated and dependable, the distinction of where the software actually resides becomes far less important. We are in the early stages of a huge transformation."