Strategic Window: WHAT A DEAL

Hostopia Delivers Gross Margin Guarantee

The pure-play wholesaler of hosting services aimed at small and medium businesses (SMBs) offers an interesting wrinkle in a market segment that has some big names fleeing in the face of competition and cost.

Industry analyst International Data Corp. projects a compound annual growth rate of 35 percent to 40 percent for SMB Web hosting within the next four years, one of the reasons that a flock of RBOCs, interexchange carriers and system integrators have entered the capital-intensive data center business during the past few years. However, a shakeout and reduction of over-capacity is under way. Since June, Intel Corp. has announced it will "wind down" its Intel Online Services Web hosting business by June 30, 2003; Loudcloud changed its name to Opsware Inc. and sold its hosting infrastructure and managed services business to EDS; and Qwest Communications International Inc. opened a search for equity partners for its own considerable hosting infrastructure. Still, AT&T Corp. opened its 22nd worldwide data center in Boston, and nary a telco, MSO, ISP or ILEC can avoid the notion that Web hosting is a must-have component of any full-service networked services play.

In other words, the market is inviting but expensive, and given the costs required to support a service aimed below the Fortune 2000, IDC says only large-scale, high-volume players with automated operations can make the numbers work.

As a form of relief, several wholesalers, including Apptix, Hostopia, Interland Inc. and NTT subsidiary Verio Inc., are trying to lower entry barriers for network service providers. Apptix and Hostopia emphasize a wholesale-only approach.

"Verio and Interland have retail hosting offers and channels that would compete with their wholesale offers, so we saw a void in pure-play wholesale hosting," says Paul Engels, vice president of business development for Hostopia, which today boasts 250 partners, most of them in North America, including a preponderance of CLECs. "Because we're truly wholesale, we never undermine our service provider brands. There's no upfront investment by our customers in servers, staff or anything else, so they see profit effectively on day one."

Hostopia services that are private labeled by CLECs, ISPs and other providers are priced to the end customer at $10 to $100 a month, while the average revenue falls between $30 and $35. "Within that $35 dollar range, we guarantee a 60 percent gross margin to our partners," says Engels, who characterizes ILECs as jealously guarding all infrastructure control, but like CLECs and other ISPs, cable operators now targeting SMBs are among those ripe for the service.

IDA Corp. subsidiary Velocitus, a packager of broadband Internet access, private networking and Web hosting for small and medium businesses, employs Hostopia's hosting services, including bundled electronic store software from Miva Corp. Velocitus appears to be managing a true down-market rate card for its end users, ranging from a $79.99-a-month, 650-megabyte service to a $34.99, and 150-megabyte service down to a basic 100-megabyte service for $23.99. The Hostopia name appears nowhere in Velocitus' marketing information.

Automation and Scale

Apptix CEO Jason Donahue estimates that Cable & Wireless plc, Genuity Inc., Qwest and other big carriers have sunk up to $75 million each in hosting infrastructure and will have a hard time reaching return on that investment any time soon. He says that such carriers could shed much of those assets and still launch private label hosting for mere thousands of dollars.

Whether wholesale or retail, the pace of payback will depend greatly on a carrier's target audience. On one end of the spectrum, sophisticated managed services targeted to the largest enterprises, delivered by major system integrators and carriers like AT&T, Genuity and WorldCom Inc.'s Digex, incorporate high-priced custom work for a select few in a relatively saturated market segment. On the other end, wholesale hosters like Hostopia and Verio are targeting a mass market of millions of unserved small enterprises. However, to do so requires large-scale hosting infrastructure, automated processes and repeatable, rather than custom, products.

Verio is building on its large down-market experience to add somewhat larger businesses to its prospects. Working with Hewlett-Packard Co.'s Compaq brand hardware. Verio launched in May a menu of Enterprise Modular Hosting solutions, incorporating application, Web, database and firewall server "building blocks," says Paul Montoya, vice president of partner management, enterprise hosting. "We can build up the infrastructure by applying repeatable, standardized parts and then add on from a menu of managed services like data backup, storage area network and firewalls." Pricing at this relatively sophisticated mid-market level ranges from $7,000 to $12,000 a month for two to five servers or $10,000 to $20,000 for seven to 12 servers, depending on how many services Verio adds on top of the servers. To help win customers to its broader offering, Verio unveiled dedicated content migration services and discounts for customers willing to move from a competitor's infrastructure.

To tackle the scale associated with serving millions of SMBs, Apptix, Hostopia, Interland and Verio emphasize they have leveraged years of experience to integrate and automate service order management, server configuration, provisioning, applications management, billing and other back-office operations -- a task that would take telcos, cablecos or ISPs equally long to replicate in house. "Even for large providers, the real cost factor and the power to differentiate lies with software, processes and people," Engels says, noting that Hostopia manages market leading, third-party applications, including online store, business class e-mail, virus protection and statistical reporting, for its customers.

Further, Hostopia offers project management, migration of existing end customers and Web accessible service management to its retail partners. It also provides outsourced, Tier 1, end customer support through call centers that integrate toll-free, Web, e-mail and chat support, including a WebsiteOS self-help site that Engels claims solves 90 percent of customer problems. While just two support calls a month can chew up margin for some services, Hostopia says it reduces those calls and can spread support costs across shared infrastructure.

"From small office-home office up through SMB to large enterprises, the highest margins have been at the high end," Engels says. "We enable dedicated hosters to concentrate on the high end, while we handle a very large, untapped mass market."

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