The downturn in the economy has forced many technology decision-makers to rethink how they spend their budgets. In some cases, products and services that in the past have been dismissed as risky or difficult to manage are now being re-considered as a potential source of cost savings. Application outsourcing – where an organisation’s core business systems are managed remotely – is one such area evolving to meet the new requirements of IT departments with shrinking budgets.

British American, a worldwide investment group, endorses this approach. In 2001, it decided to standardise its financial systems worldwide onto Oracle’s 11i Financials package. Realising that it did not have enough sufficiently skilled staff to manage the package across its global operations,

or a server large enough to implement and manage the system itself, the company handed back the management, support and maintenance of the system to Oracle.

“We were looking for low start-up costs, real-time support, rapid roll-out and a flexible, scalable IT environment that would meet our application and growth requirements,” says programme manager David Connoley. British American claims the agreement with Oracle will save $500,000 in one year in IT staffing and administration costs, and enabled the company to get the Oracle package up and running in just 68 days.

The kind of enthusiasm British American displays for outsourcing its business applications is rare, however. In the late 1990s, many software companies adapted their business models to become application service providers (ASPs), claiming they could save customers hefty software purchase and maintenance costs by allowing them to access these applications over the web. However, the market soon became overcrowded, and many ASPs were burdened by security problems, insufficient bandwidth and unworkable service level agreements. As a result, the ASP moniker, and anything associated with it, acquired a reputation for being problematic with customers and analysts alike.

A case in point was UK financial management software vendor QSP. In November 2000, QSP opened what it described as a “state of the art” data centre at its UK headquarters, boasting that its ASP business would have about 20,000 users by the end of 2001. Exactly 12 months later, the company folded after 20 years in the software business.

New direction

But strategic decisions to outsource applications by companies such as British American indicate that some organisations are reconsidering how they view this market. Whereas first generation models of application hosting “only tended to work for [straightforward] IT operations, such as email management and web hosting,” according to Forrester Research analyst Charles Homs, second-generation application hosting providers now offer sophisticated management of large-scale enterprise applications such as enterprise resource planning systems, customer relationship management packages and database applications, while still helping organisations achieve reduced software ownership costs.

Crucially, a number of the inhibitors that arose in the past to using an application hosting provider have now been removed. With the introduction of high-speed Internet transport mechanisms such as broadband and Gigabit Ethernet, bandwidth is less of a problem. And because enterprise applications from vendors such as PeopleSoft, SAP and Oracle have largely been re-written in Java so they are accessible over the Internet and require no code to reside on the client device, it is now far easier, and more cost-effective, to manage software remotely.

As British American’s experience shows, with these barriers removed, these cost savings can then be passed on to customers. Application hosting provider Corio, for example, has slashed the cost of providing its services to customers by around 20% to 25% per year. “We feel very comfortable promising customers potential cost savings of around 25%,” boasts CEO George Kadifa.

These potential savings are proving very attractive. Oracle, for one, claims it is now gaining hundreds of ASP customers in both the mid- and high-end of the market – companies with revenues between $50 million and $1 billion that want to slash overheads. “A tremendous amount of money in an IT budget is used not to buy hardware and software, but to manage the software that companies have bought,” explains Tim Chou, president of Oracle’s application outsourcing business. “The cost of purchasing software compared to the cost of managing it is two to four times greater.”

This is because, in many organisations, managing their core enterprise applications usually requires hiring a team of in-house staff with specialist skills. According to Martyn Proctor, services director at ITNet, a UK-based IT and business process outsourcing specialist, hiring an Oracle database administrator (DBA) can cost around £15,000 over a period of six months. On top of that, IT departments need to constantly fine-tune the business processes underpinning these applications, ensure the systems are available on a 24/7 basis, and apply security patches where needed. “The lion’s share of software costs go on managing the production environment,” says Michael Greatorex, IBM’s application hosting manager for Europe, the Middle East and Africa.

The vendors of packaged applications, such as Oracle and SAP – as well as systems and services giant IBM – have been quick to spot these ‘pain points’ in organisations and develop packaged applications services to address them. The application hosting business of these software giants is based on one simple argument: That the software suppliers themselves will typically know about problems with their own software before their users, and as a result, can deliver patches, fix bugs and offer enhancements far more efficiently than through the usual, indirect channels. As Chou explains, “no one can manage Oracle software better than Oracle”.

Custom built

Despite these apparent benefits, applications outsourcing may not be suitable for all types of business. Enterprise applications tend to require heavy customisation in order to provide a close fit with an individual organisation’s business processes – something that is difficult to deliver on a one-to-many basis. Whereas application hosting companies can now offer some customisation capabilities, these tend to be limited, so customers must accept a more-or-less standard offering from such providers. “Application outsourcing is attractive for companies that want to standardise their applications and IT infrastructure across their operations,” explains Bill Martorelli, an analyst at Giga Information Group.

As a result, many organisations employ an application outsourcer when they embark on a significant change in their IT strategy, for example migrating a large number of users over to a new suite of software and systems. North Carolina, US-based National Gypsum, a supplier of building and construction products, did just that in 2001. In order to improve the efficiency of its PeopleSoft Financials system, Gypsum decided that it would have to move users off the company’s existing mainframe and database. After analysing the cost of this project, Gypsum decided to outsource the project, and the subsequent management of its PeopleSoft Financials package, to application service provider Corio.

Corio moved Gypsum over to a completely new hardware and software infrastructure, which meant that it also had to provide some customisation of Gypsum’s applications for a new Oracle database environment. In addition to improved software performance, Gypsum claims that Corio’s service has enabled it to cut IT costs by around 25% per year. “Corio’s application management resources will alleviate our need to hire the PeopleSoft skills in-house, reducing our total cost of ownership,” says Bill Parmelee, chief financial officer at Gypsum.

But analysts at Giga warns that such a strategy may not meet with the same success at other organisations, particularly those with a wide range of enterprise applications. “Application outsourcing is not typically used by companies that have embraced customisation. Companies that have a lot of diversity in the type of software they use tend to want to manage their own applications,” he says.

Other analyst groups concur. Brian Wood at Gartner says companies should consider the application hosting service of IBM, for example, as a way of minimising risk and initial investment cost. But “customers with highly customised Siebel [customer relationship management software] and SAP implementations already installed should be cautious when considering application hosting, because IBM will find it difficult to become familiar with the nuances of their existing service level agreements.”

Ultimately, however, the real promise of application outsourcing is that organisations can spend less on managing software and spend more on application innovation. “If the IT industry does not somehow cleave into this huge chunk of money then innovation is stifled as time wears on,” warns Chou at Oracle. He adds, “This is the most significant change in the software industry since it was born.”