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Outsourcing: Should It Stay Or Should It Go?

Companies are finding a host of reasons to offload bits of their E-business operations.

With traffic to its consumer Web site doubling nearly every year since 1996 and online transactions surpassing $100 million annually, Amtrak knew its E-business operation was strained to capacity. Its first thought: outsource everything. So in late 2000, E-commerce directors Mary Cortina and Lenetta McCampbell sorted through proposals from Digex, Exodus, IBM, and Loudcloud, companies that, as Cortina says, “definitely knew their business” in terms of technology. But the price tags proved too steep, so Amtrak added staff and transformed a data center originally intended to support legacy applications into a new E-business hub.

In general, Amtrak executives say that approach made sense: the price was right and the site has performed well. But when the September 11 terrorist attacks drove hundreds of would-be travelers to amtrak.com, the rail line didn’t stand a chance. Its three-person IT staff couldn’t add bandwidth fast enough to meet demand, and call centers were overwhelmed, forcing Amtrak to turn away potential customers.

The outsourcing option returned, and in an unusual way. Cambridge, Massachusetts-based Akamai Technologies Inc., a provider of E-business infrastructure, let Amtrak reroute Web traffic through its servers for free for one month following the attacks, solving the bandwidth problem. “They literally saved our site,” says Cortina. As a result, Amtrak changed its mind about outsourcing and signed a deal with Akamai. Its former all-or-nothing view gave way to a mix-and-match approach in which, as McCampbell says, “the combination of internal support and outsourcing means that spikes can be handled more efficiently,” whether caused by emergencies, holiday traffic, promotions, or other reasons.

While outsourcing decisions are rarely born of such drama, analysts say a growing number of companies are now realizing that E-business operations are difficult to handle alone. “We expect that companies will have to ship out at least some component” of E-business, says Jeanne Schaaf, formerly an analyst at Cambridge, Massachusetts-based Forrester Research. “Companies that do it all themselves tend to overspend on bandwidth, storage, networks, and personnel.”

Choose Your Partner(s)

Research firms say that slightly more than half of U.S. companies still maintain all E-business operations in-house. “There’s a cowboy mentality at some companies, where they want to do E-business all themselves. The CIO wants to be able to walk down the hall and pet the server,” notes Marc Jacobson, an E-business analyst at Ovum, a Wakefield, Massachusetts-based analyst and consulting firm. But as E-business infrastructure grows to accommodate large-scale applications like customer relationship and supply-chain-management programs, he says, “going forward, the in-house approach is simply not going to work.”

Outsourcing options abound, so much so that some companies are rife with outsourcing relationships, a situation often exacerbated by the fact that various departments within a company may establish separate approaches to E-business. Germany-based sporting-goods maker Adidas-Salomon AG, for example, relied on 15 companies to host various components of its adidas.com site before it consolidated with one company last summer.

Analysts say that one way to handle E-business outsourcing is to find one company that can do it all, but won’t insist on doing so. Such managed service providers (MSPs) as Sunnyvale, California-based Loudcloud Inc. (which now handles adidas.com) act as a sort of general contractor, making sure clients get whatever services they need and tapping a network of providers for the underlying hosting facility, security systems, or whatever else is needed.

If Loudcloud’s recent fortunes are any indication, the MSP model has legs. “A hoster without a data center,” as consulting firm Gartner describes it, this high-profile start-up boasts Netscape co-founder Marc Andreessen as its co-founder. For that reason, perhaps, Loudcloud was one of the few technology companies to weather the chilly initial public offering market last March. Despite a less-than-dazzling stock price (it peaked at $7 a share in May and sank as low as $1.12 in September before climbing to the mid-$4s at press time), Loudcloud posted triple-digit year-over-year revenue growth for its two most recent quarters. By leveraging other companies’ data centers rather than buying its own, and offering up slick technology–its Opsware software can automatically commission servers, patch glitches, and more–the company, analysts say, has some strong cost advantages. As its net losses steadily decrease, Loudcloud believes it can not only turn a profit in 2003 but also become a major force in E-business. How major? “We aspire to be the next IBM,” says CEO Ben Horowitz.

In fact, the buzz around MSPs is so strong that some customers find it difficult to cut through the hype. Another Loudcloud client, USAToday.com, met with a variety of would-be outsourcing partners ranging from hosting companies to phone companies, all claiming to be in the MSP business. But Adriaan Bouten, vice president of IT for USAToday.com, soon found that “while everyone was trying to be an MSP, many of them wouldn’t put their service-level agreements behind their pitches.”

Loudcloud won the business last August, both because it agreed to rebate more than 100 percent of its service fees during downtimes and because its approach to E-business infrastructure was “about 90 percent” congruent with what USAToday.com already used.

Indeed, congruency can be a major factor in whether an MSP makes sense. “When you go to a hoster or an MSP, a lot of times you have to make a lot of concessions, because in order to be successful, they need to standardize their offerings,” says Gartner analyst Ted Chamberlin, who notes that this has been a common problem for his clients. “They may say, ‘We know your systems are sitting on a Linux box, but we think they need to be on Windows,’ because that’s what they’re using for everybody else.”

Standardization, however, allows for big savings on commodities like storage and bandwidth. Bouten, for example, says buying through Loudcloud saves him 50 percent on bandwidth costs. Standardization also creates flexibility: a hoster can increase a client’s capacity at a moment’s notice, while companies that handle E-business in-house usually carry extra capacity so they can add it when they need it, an approach that is not cost-effective.

E-business outsourcers also offer the advantages associated with other, more traditional forms of outsourcing: economies of scale and (in theory) qualified staff. “That means they can provide a tighter level of security than we could alone,” says Rob Hack, director of global information technology and infrastructure at Syracuse, New York-based Carrier Corp., a United Technologies company, “because they can spread the overhead across a number of clients.” Carrier signed on with Genuity Inc. five years ago and now has about 60 Web sites on more than 20 servers under Genuity’s care, including customer- and supplier-facing extranets. Using an MSP, says Hack, provides predictable service levels and response times in a secure network and computing environment that complements site-level and back-end security.

Staffing issues also drive outsourcing strategies. The “war on talent” continues to rage in technical areas, and even companies that create software for a living often lack the IT expertise needed to run E-business operations in-house. “Building applications is not the same thing as managing IT,” says Nicholas Zaldastani, senior vice president and chief marketing officer at Personic Inc., a Brisbane, California-based software firm that specializes in corporate recruiting and hiring. Personic acts as an ASP (application service provider), renting its software to clients. And it relies on MSP Digex to make sure the systems run properly.

The need to keep things running, in fact, motivates a move toward some form of E-business outsourcing far more often than the ability to actually cut costs. “I could have generated some savings out of our old approach without making the change to Loudcloud,” says Bouten, “but I couldn’t have achieved all that we needed to do, and there would have been more risk, since I didn’t have the right expertise on staff.”

Reliability plays a key role in measuring the ROI of outsourcing. At Carrier, “the analysis really boiled down to ‘what would the gross margin loss be if our sites were not available?’” says Hack. Given that the HVAC-products manufacturer draws about $1 billion worth of business through its Web sites and “there is no sympathy” from its user community for technical failures, the upgrade seemed essential.

While cost may not be a prime motivator, analysts say it is a buyer’s market, as the herd of mostly young, unproven MSPs fight to build market share. Monthly fees range from $30,000 to $70,000, with $10,000 a bare minimum. Loudcloud says its customers pay an average of $1.5 million annually, or $125,000 a month. Meanwhile, Chamberlin of Gartner expects prices for hosting services to rise from 10 percent to 20 percent annually over the next several years to meet profit pressure from Wall Street. “If your balance sheet allows it, and you’re Web-enabling some services, you’re in a prime position right now,” says Ovum’s Jacobson. “Next year you’ll have much less chance to negotiate the sweet deal you could today.”

The recent bankruptcies of hosting giant Exodus and ASP pioneer USi have raised doubts about some of the business models used by ASPs and MSPs. However, some analysts say that by establishing alliances with telecom firms (Loudcloud with Qwest, Digex with Worldcom, and Genuity with Verizon), questions about stability become moot. “It’s more a question of whether they will stand alone or be integrated into the partner,” says Andrew Schroepfer, president of Minneapolis-based Tier 1 Research. Either way, as companies increasingly rely on the Web, they will almost certainly come to rely on an expanding web of technology providers.

For Genuity, Flex Time

For a lesson in the appeal of the à la carte approach to E-business outsourcing, look no further than the recent fortunes of Loudcloud and Genuity. These two MSPs provide essentially the same services to large companies, yet Genuity’s revenue from these activities dropped 5 percent year-over-year (as of November), while Loudcloud’s rose 200 percent.

Analysts say flexibility is the differentiator. Loudcloud has long touted its ability to take on selected portions of E-business on various platforms, while Genuity has tried to steer clients to comprehensive integration. “A multinational company with 50 different business units that have their own Web sites and enterprise applications would have to move all of them to a single platform to sign up with Genuity,” explains Andrew Schroepfer, president of Tier 1 Research. Loudcloud, however, “would let a client outsource piece by piece, while working toward an integrated platform.”

Genuity has seen the light, says Schroepfer, and now offers a platform that can be purchased in smaller increments. A recently announced partnership with PricewaterhouseCoopers should help spread the new message, but ultimately the company’s best shot may be to merge back into Verizon, which spun Genuity off last year as a requirement of its merger with GTE. Verizon is currently applying for regulatory relief in order “to bring us back into the fold in some way, shape, or form,” says Joel Whitman, Genuity’s vice president for product marketing and Internet strategy.

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