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2002 � The Year of ASP Consolidation

If the mergers and acquisitions that abounded in 2002 are a sign of things to come, you'll soon be able to count the number of pure-play ASPs left standing on one hand. That's the stark truth about the ASP market, but it's also a sign that the industry is coming of age.

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"There is a limited number of large corporate accounts to chase, and these companies have existing relationships with big organizations like EDS and IBM, so they tend to look to them. The newer ASPs have little choice but to consolidate to survive."

—Laurie McCabe
Summit Strategies

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There's certainly been no shortage of high-profile M&A activity over the past months to serve as examples of this trend: USi and Interpath, Agilera and United Messaging, EDS and Loudcloud, Corio and Qwest Cyber Solutions — the list goes on.

But this level of this activity shouldn't be a surprise. Most new industries are characterized by numerous small, innovative market entrants, but rarely do these ground-breaking companies end up being the dominant forces in the industry. Unsuccessful ones fall by the wayside, while successful ones are picked off by larger corporations with more resources.

Tough Market to Crack
To understand the timing of this consolidation phase, it's worth looking at the market the pure-play ASPs have been chasing. "ASPs who service and support large enterprise apps are dealing with large enterprises as the services are still too expensive and complicated for SMEs [small and medium-size enterprises]," Laurie McCabe, vice president at Boston-based research company Summit Strategies, told ASPnews. "There is a limited number of large corporate accounts to chase, and these companies have existing relationships with big organizations like EDS and IBM, so they tend to look to them. The newer ASPs have little choice but to consolidate to survive."

If other industries are anything to go by, the move towards consolidation will be extreme. "There will probably be no more than two or three (ASP) suppliers in the end," Ben Pring principal analyst at Gartner Dataquest, told ASPnews.

"This is part of an inevitable Darwinian process — survival of the fittest — and every industry goes through it. The rate of startups has slowed enormously as venture capital has dried up, and we have seen bigger companies like telcos, systems integrators, outsourcers expanding their ASP/hosting offerings. This is increasingly a game for bigger players now that the innovation has been done by the smaller ones."

The consolidation is certainly not corporate activity for corporate activity's sake: There are two main reasons for companies buying up ASP market players. The most important one is to reach critical mass by acquiring more customers. More customers means more revenues. Also, by increasing operating efficiencies through staff reductions, increased data center and network usage, and reduced sales and marketing spend, profitability should be higher. This type of consolidation usually takes place when ASPs involved in similar activities are involved, such as the recent Corio/QCS deal.

Less frequently, large companies take over smaller ones. In these cases it is not the customer base that the buyer is after, but rather expertise or particular intellectual property. Agilera's acquisition of United Messaging can be explained by a desire on Agilera' part to meet its existing customers' demand for messaging, while when EDS took over Loudcloud earlier this year, it was the Opsware software that Loudcloud had developed that EDS was interested in.

Still a Place for Specialists
Putting application service provision into the hands of a small number of powerful players does not necessarily mean that ASP services will be available only from a limited number of suppliers. The way Microsoft's hosted Exchange 2000 is delivered as a service provides a clue as to how the industry as a whole may develop. ASPs such as Apptix have built up expertise in Exchange and offer it as a service to other ASPs to deliver under their own label to their customers (see Apptix, HP Offer Exchange On Demand).

It's quite likely that in the coming years we will see enterprise applications offered to end users by professional services outfits, small systems integrators specializing in particular industry verticals and other non-ASPs — with these companies retailing ASP services they buy from ASP wholesalers, according to Pring.

If this proves successful, it's interesting to speculate about what sort of company these wholesalers might be. It could well be that one or more of the existing pure-play ASPs could succeed in that business model. You could make a compelling argument that any of these companies would be small beer for an EDS or IBM to swallow up, but that they would be tempting acquisitions for large service companies if other value added services could be bolted on. Equally, telcos — who can't be counted on to fail in the ASP market forever — certainly have the resources to buy their way in to the end game if they wanted to.

Speaking the Native Language
The only part of the industry that's not heading for consolidation is the Web native ASP sector (i.e., companies such as Salesforce.com, NetLedger and Intacct), Summit Strategies' McCabe said. "I think they have a completely different path. Their futures look very rosy and I think we will see a lot of new companies in that sector." (See Web-Native ASPs Lay Down the Gauntlet).

Gartner Dataquest's Pring agrees. "We're very positive about the Web-natives. The enterprise ASPs like Corio are the bridge from the old client service model to the Web native model. Web-native is the future."


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