The Data  Center Opportunity

Outsourcing Boom Expedites ISP, Telco Buildout Plans

It seems like everybody wants to be in the Internet hosting business these days. Data centers for collocation, website and applications hosting are mushrooming around the country and the world.

"The hosting market has exploded lately, and we're seeing a lot of new square footage," says Jose Garcia, vice president of business service providers and emerging markets for IBM Corp.'s Enterprise Systems Group (www.ibm.com), which sells server products.

Data center stalwarts quickly are adding new centers while many ISPs and telcos are expanding into the business via new builds or acquisition.

All of the above are moving to provide space in which corporations or other service providers can locate their web servers. Most also will offer managed services, configuring and maintaining websites or equipment for companies--enterprises, ASPs or other service providers--that wish to outsource those functions. As these data center operators move to climb the value stack, many also are beginning to offer professional services and, in some cases, act as ASPs themselves or in partnership with providers of popular software like Microsoft Corp. (www.microsoft.com), Oracle Corp. (www.oracle.com), SAP AG (www.sap.com) and Siebel Systems Inc. (www.siebel.com).

Research firm International Data Corp. (www.idc.com) forecasts that the U.S. hosting services market will grow by nearly $1 billion this year, bringing it to more than $1.8 billion. And it expects that to increase by a factor of 10 through 2003.

Forrester Research Inc. (www.forrester.com) believes the U.S. web-hosting revenue will reach $19.8 billion in 2004, having put it at $1.4 billion for 1999. "Users' drive toward high-end e-commerce sites coupled with vendors' focus on web solutions puts hosting on a path to the stars," according to a May 2000 Forrester report on the topic.

Frost & Sullivan (www.frost.com) estimates the web hosting marketplace will be worth more than $35 billion in the United States by 2005.

Bear, Stearns & Co. Inc. (www.bearstearns.com), meanwhile, notes that "web hosting companies are experiencing robust growth from customers with larger average contract sizes" and that that shows "no sign of abating anytime soon."

Of course, all the growth is being driven by the fact that the Internet has become part of everyday life for both businesses and consumers. Estimates of the number of people online grows daily. As a result, more "dot coms" and established businesses now offer goods and services on the web. Meanwhile, businesses are using the Internet internally for training and other purposes, and to connect with other businesses for supply chain management. According to Forrester, by 2004, 1.48 million U.S. businesses--23 percent of the total--will boast websites, almost double today's count. And by 2004, e-commerce-enabled sites will generate 91 percent of all hosting revenue, Forrester forecasts.

But running web servers and the infrastructure surrounding them is not a core competency of most of these businesses, so they're looking outside their doors for the space, equipment and human resources to handle those functions (see "Websites: Outsourced Vs. In-house" diagram).

Diagram: Websites: Outsourced Vs. In-house

"The main value proposition is it's better, faster, cheaper," says Sam Mohamad, president of worldwide sales and international field operations with Exodus Communications Inc. (www.exodus.net). "In the old days, outsourcing gave you an advantage of two to one, meaning you saved half of your costs. Now it's more like six to one because there's so much more involved in running an Internet operation.

"An IT operation would normally run regular business hours," he says. "With the Internet all of a sudden you go to 7/24 [seven days a week, 24 hours a day] because customers are worldwide, so all of a sudden you need not one shift but three shifts. We do that and aggregate the costs across multiple customers" (see "Reasons for Outsourcing Websites").

Diagram: Reasons for Outsourcing Websites

The equipment and peering involved with web hosting also can be cost prohibitive for a single organization, he adds.

"The market demand is just insatiable" for data center services, Mohamad says. "It's a no-brainer type of a service."

The Great Expansion

While collocation continues to be a profitable business for companies that run data centers, that strategy is becoming a commodity. The need for managed services is what's driving the rapid buildout of new data centers, most agree (see "Projected Revenue by Hosting Segment"). According to Ruth Chatterton, senior consultant with TeleChoice Inc. (www.telechoice.com), the margins for collocation are relatively low, usually 10 percent to 20 percent. "For hosting they can be terrific--they can be 50 percent," she says.

Diagram: Projected Revenue by Hosting Segment

UUNET Technologies Inc. (www.us.uu.net), a WorldCom Inc. company that got into hosting back in 1994, expects to spend more than $1 billion building out data centers.

"It's one of the key strategic initiatives we have," says Mitch Ferro, director of hosting products at UUNET. "We really believe our business is not just providing the raw connectivity. This is really part of providing the customers the platform."

The company now operates six data centers in the U.S.--in Atlanta; Carteret, N.J.; Dallas; Elmsford, N.Y.; San Jose, Calif.; and Tyson's Corner, Va. Each is in the 40,000- to 50,000-square-foot range. The company plans to launch service at an additional 13 centers, averaging 110,000 square feet each, by the end of this year. Boston, Chicago, Denver, Houston, Los Angeles, Miami, Seattle, St. Louis, and Washington, D.C., are the next data center locales on the map. And the company is supplementing its existing centers in Atlanta; Dallas; the New York area; and San Jose, Calif.

"We don't build data centers to be in the real estate business," Ferro says. "We are in the network services business. We are offering collocation, but collocation is not just the real estate; it's the network connectivity.

"Our real focus is on the dedicated hosting," he adds. "We offer the customer a platform for their applications. We support SQL [Microsoft's database] on NT or Oracle on Solaris, but the customer is responsible for everything above that application."

Still, Ferro notes that collocation, which now accounts for 25 percent of UUNET's data center revenues, is expected to account for 50 percent in a few years. "We expect the revenues [for collocation] to grow very quickly because what you're really selling is bandwidth," he says. "And we can deliver that overnight, whereas it takes time to test and design management services, so collocation revenues can grow a lot faster."

UUNET also offers "flex products" that give customers root access to servers, says Ferro. For example, if a customer wants to run a third-party application that UUNET doesn't support, it will enable the customer to administer the server, he says.

Qwest Communications International Inc. (www.qwest.com) also has been aggressive in its data center buildout.

It is investing hundreds of millions of dollars for the data center program. An individual "CyberCenter" typically costs $40 million to $50 million to get started, according to Kurt Cohen, vice president of hosting and collocation services at Qwest. The break-even window is 12 to 18 months, he says.

"We continue to build more and bigger centers," says Cohen. "[Hosting] is a small but growing piece of our business," he adds.

The company ended 1998 with centers in Denver; San Francisco; and Weehawken, N.J.; each of which it acquired, and each of which was under 500 square feet. Last year, Qwest built larger data centers in Burbank and Sunnyvale, Calif.; Newark, N.J.; and Sterling, Va. This year the company expects to add 100,000- to 200,000-square-foot centers in 10 major cities.

Qwest is actually working with IBM Global Services to build out 28 of these centers. The multiyear deal is expected to generate more than $5 billion in revenues for the two companies.

"IBM has experience building data centers--they've managed large buildouts. And we're trying to build an enormous amount of space," says Cohen. "Plus, IBM will lease approximately a quarter of the space in each center. Since IBM is an anchor tenant, we can build more centers than we could have alone. We [can also] provide high-end services, not just space and bandwidth."

That's because Qwest will adopt IBM's managed operations skills, policies and procedures. IBM also will provide personnel on a contract basis to run the Qwest CyberCenters. Finding and keeping skilled technicians to keep the servers running is a formidable task, says Cohen. Over time, however, Qwest expects to bring that personnel back in-house, he says.

Qwest is providing collocation services through its CyberCenters. It also offers to monitor customers' servers, although the customer would still own and run the server in this scenario. Through its premium service, Qwest will manage Unix and NT servers completely for customers with web server and streaming media applications. It also has a professional services group that will design websites, do integration and support any other stable applications that fall outside the purview of the premium service. And in June, the company added a service called Qwest Control, through which customers can remotely view server and web statistics, open trouble tickets and--in the future--configure their web servers that are at the CyberCenters. In addition, Qwest CyberSolutions, an ASP joint venture of KPMG (www.kpmg.com) and Qwest, uses the CyberCenters to host applications from companies such as SAP and Siebel.

Today, about 35 percent of CyberCenter revenues come from the premium services. The rest is basic and monitoring services.

For its part, IBM has 133 data centers in operation globally. Late this spring it announced plans for 56 additional centers to be built out over the next two years.

IBM offers collocation services ("pipes, power and ping"), managed services and fully managed hosting.

"A lot of people will tell you they do fully managed, but they offer two hours of support" in the event of an outage, says Warren Hart, director of global offerings for web hosting at IBM Global Services. "We retain root access, we handle OS, database layer currency and bundled value-added services."

Another major player in the hosting space, PSINet Inc. (www.psinet.com), is hurriedly building new infrastructure as well. Having recently accelerated its spending on web hosting, the company expects to have 20 hosting centers operational by the end of this year, representing more than 1.5 million square feet of space. It plans to open centers in Berlin; Boston; Buenos Aires, Argentina; Dallas; Geneva; Hong Kong; Miami; Paris; San Paulo, Brazil; Seoul, Korea; and Sydney, Australia later this year.

All the centers will offer corporate Internet access, security, hosting and e-commerce. Among the new services being offered through the new centers is Transaction Link, which permits dedicated hosting customers to run their own payment servers to every major credit and debit card processor through a single Internet connection.

PSINet currently operates a total of 330,000 square feet of hosting centers in Amsterdam, the Netherlands; Atlanta; Herndon, Va.; Los Angeles; London; New York City; Neuchatel, Switzerland; Toronto; and Tokyo. At the close of the first quarter of 2000, the company provided service to more than 98,000 corporate accounts, a 66 percent increase from the previous year, as well as more than 360 ISPs reaching more than 1.3 million end users. The company saw a 35 percent increase in worldwide hosting center revenue in the first quarter of this year.

In June, Williams Communications Group Inc. (www.williamscommunications.com) announced plans to spend $1 billion over the next several years to build dedicated data centers, expand its network collocation facilities and to scale up its IP network. During the past two years, Williams has built collocation and data center facilities totaling more than 1.25 million square feet. The new capital project will be used in part to construct and equip new or expanded collocation and data center facilities, increasing space by nearly 700,000 square feet.

And Exodus, which operates 22 data centers worldwide, plans to expand from the 1.7 million square feet of data center facilities it was operating at the end of last year to 3.9 million square feet by the end of 2000.

The Next Shot

Meanwhile, new entrants are coming onto the scene.

In March, PRIMUS Telecommunications Group Inc. (www.primistel.com) and Hewlett-Packard Co. (www.hp.com) unveiled an alliance to deliver e-commerce, web hosting and Internet services. The plan has PRIMUS expanding its data centers in Australia, Brazil, Japan and Western Europe to 10,000 square feet.

In April, AT&T Corp. (www.att.com), British Telecommunications plc (www.bt.com) and Concert Communications Co. (www.concert.com) announced plans to invest $2 billion over three years to deliver global e-commerce services through a network of 44 Internet data centers in 16 countries including 14 facilities already in service. In the United States, meanwhile, AT&T recently announced plans to have new or enlarged data centers in New York City, Phoenix, San Diego and San Francisco by midyear.

Also in Europe, Digex Inc. (www.digex.com), one of the leading data center companies in the United States with facilities in the Washington, D.C. area and San Jose, Calif., established a European subsidiary, which has opened a new data center in London. This subsidiary will allow the company to provide managed hosting services to European companies.

CLECs are getting in on the act too.

For example, e.spire Communications Inc.'s (www.espire.net) subsidiary ValueWeb (www.valueweb.com) in March expanded its hosting options to include dedicated server and collocation services (to date it has focused primarily on shared hosting) and in January moved to a state-of-the-art facility in Ft. Lauderdale, Fla. Hosting is expected to become a growing piece of e.spire's business.

"ValueWeb, an important e.spire asset, along with our Internet access provider CyberGate, contributed more than 10 percent of e.spire's revenues in 1999 by providing basic Internet services, including basic hosting and e-commerce," said George F. Schmitt, e.spire chairman and acting CEO, in a June press release. "With an expanded ValueWeb portfolio, we hope to realize improved margins and financial results that will increase our Internet subsidiaries' contribution to our bottom line."

DSL.net Inc. (www.dsl.net) has added web hosting and other services to its portfolio through the acquisition of data center company Vector Internet Services Inc. (www.visi.com).

FirstWorld Communications Inc. (www.firstworld.com) opened a 35,000-square-foot Internet data center in Portland, Ore.

And a carrier's carrier called Evolution Networks Inc. (www.evnetworks.com), which expects to break ground this month or next on its network in Tier 2, 3 and 4 cities, will build 25 data centers in secondary markets to add value to its transport network. Through its data centers, Evolution Networks expects to offer collocation, server hosting and storage management initially. "As we get more proficient doing that, we'll be moving to applications management--not creating applications but helping manage those applications," says CEO Eric Ensor.

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