In fact, in today's tough economic times, the benefits of hosted solutions appeal more than ever to customers' renewed sense of pragmatism. Customers are increasingly interested in outsourcing all types of functions--including IT -- to cut time and costs, and reduce risks. But, of course, these same customers want to buy services from vendors that can satisfy their actual business requirements, offer them a solid return on their investment and stick around over the long haul.

Evolution of a Species
Our interpretation of this somewhat contradictory data is that, as in any ecosystem, the forces of natural selection are at work. Companies that are poorly suited or can't adapt to market requirements are dying off, while stronger ones are both surviving and adapting to become even stronger.

Some key factors that can help these survivors become more resilient in 2002 include:

• Substance trumps style. This industry is riddled with vendors that spent absurd sums of money on high-air-cover marketing while ignoring the nuts and bolts of business. Who can forget Agillion's multimillion-dollar Super Bowl ad? Everyone but ASP industry watchers! And what about FutureLink's exorbitant expenditures to build its own data centers--when it could have leased existing top-flight space at a fraction of the cost and risk? While those companies burned through their cash, service providers as diverse as Employease, Interland, World Technology Services, Concur and Dorado instead created services tuned to customer requirements; built channels that would get them customer "face time" and close sales; and kept infrastructure investments in line with revenue growth. Today, they boast growing revenues, satisfied customers and strong channels--a much stronger foundation for a marketing campaign;

• Smart partnering beats the "one-stop shop." Many early "pure-play" ASPs, such as FutureLink and USinternetworking, made huge capital investments to build and tout the advantages of the one-stop ASP shop. But providing all the elements of the solution--from data centers to sales to consulting services--was too much for one vendor to do well and profitably. Meanwhile, vendors such as Appshop, Concur and Prentice Technologies that knit together multiple partnerships to augment their own core competencies are reaping rewards;

• Square pegs don't fit into round holes--in technology or business. Pure-play ASPs that host third-party solutions bet on retrofitting ISVs' legacy solutions for Internet hosting. Presumably, these ISVs have established brand equity and market penetration on which ASPs can piggyback. But ASPs in this mode must also depend on their ISV partners' willingness to adapt solutions, pricing and business practices to accommodate the hosting model. On the flip side, other service providers decided to build and deliver "born on the Web" solutions optimized for Internet delivery from the start. Although they initially sacrificed brand equity, in the long run their desire to get ahead of the Internet-services curve should pay off on both technology and business fronts;

• Focus brings scalability and volume efficiencies. It's tough for a startup service provider to build an efficient, profitable business that encompasses eight or 10 different enterprise applications, or to market and deliver high-quality managed-infrastructure and -application services simultaneously. In fact, xSPs such as Interliant, Breakaway Solutions, Agiliti and Agilera couldn't do it, and pared down their offerings in 2001 (Breakaway subsequently filed for bankruptcy in September of 2001). In 2002, service providers that focus on core offerings or specific market segments will harvest the dividends that come from repeatable experiences and automated processes.

• Service providers need to add new revenue streams. To attract more customers and garner a bigger chunk of existing customers' wallets, providers need to add new services continually. Although this may seem contradictory to the call for focus we've mentioned, it really isn't. Vendors with focus are better tuned into their markets, and they're well positioned to augment their base offerings with new services that these markets actually want and need. Needless to say, this also makes what they peddle more attractive to new distribution partners in their target markets.

• "Have it your way" is a better pitch than "my way or the highway." Companies' decisions to outsource IT applications and services, or to do these things themselves, aren't black and white. The overwhelming majority of companies will end up with a mixed bag of internally and externally deployed and managed systems. Providers will have the strongest market advantages when they give customers a choice of where systems physically reside, provide good visibility into their services and give customers flexibility in terms of how much--or how little--control they want to exert..

Because the potential market for hosted software services is enormous, and the customer segments within in it are infinitely diverse, there is no one formula that will dictate success or failure. But, as the ASP industry recovers from its 2001 hangover, players that learn from early mistakes can adapt and flourish in 2002 and beyond.