IMN CONFERENCE
Analysts: Hosting Models Can Work
But pricing, financing are major challenges, and the RBOCs are lurking

July 27, 2001 (SAN FRANCISCO) -- Are web hosting and colocation businesses struggling because their business models don't work during a capital crunch? Or are they struggling because these models don't work at all?
Wall Street financial analysts say well-managed companies can become profitable by capturing enterprise customers and improving the profit margins on the services they're selling.
But they cautioned that pricing pressures and the lack of funding present huge challenges, and facility operators may have a limited window of opportunity to make their models work.
"Both consumers and businesses have irrational pricing expectations and want something for nothing," said Rick Juarez of AlphaCap Ventures LLC.
He said the pricing problem was reflected in the gap between the cost of running an enterprise web site in-house - which Juarez estimated at $5.3 million over five years - and outsourcing the same web site, which would cost just $1.4 million.
Proponents of managed hosting models might cite that figure as a compelling argument for explosive growth in outsourcing. But Juarez says it shows that hosting companies aren't charging nearly enough for these services, leaving them grappling with tighter profit margins.
"Are we giving away the ranch?" Juarez asked the audience Friday at the IMN Summer Conference on Financing and Developing Carrier Hotels and Internet Data Centers. "There's a risk of data center getting pigeon-holed in low-margin services."
He compared colocation to long distance telephone service.
"It's very valuable, and you've got to have it, but no one wants to pay for it," he said. "The pricing's out of whack. I think that's something the industry trained users to expect, and that's why EDS and IBM never jumped in."
The key to succeeding, the analysts said, is for colocation and hosting providers to shift their customer base from struggling dot-coms, CLECs and carriers to large corporations.
"Historically, the low-hanging fruit was the carriers," said Frank Murphy, a director with First Union Securities. "The more long-term focus has to be on the enterprise customers. The way to (capture enterpise business) is product innovation."
That's not an easy thing to establish, he acknowledged.
"In web hosting and colocation, it's very hard to build a better mousetrap," said Murphy. "You can differentiate yourself today, but tomorrow everyone else will be doing the same thing."
Complicating matters is a slowdown in information technology spending. Juarez noted surveys saying the number of enterprises planning to expand IT spending has shrunk from 70 percent at the beginning of the year to 41 percent today.
In addition, large customers are taking longer to make decisions. "It's the CIO dilemma - why be fired today when you can stretch out the decision and be fired in six months?" he said.
Juarez cited customer decision making as a particular dilemma for Exodus Communications, the giant managed hosting firm he recommended in his previous position as an analyst at the San Francisco brokerage Robertson Stephenson.
Juarez said Exodus' revenues were essentially flat between the first and second quarters. "I wouldn't be surprised to see their revenue go down in the third quarter," he said. "What is happening is they are seeing delays."
So what's a struggling colocation or hosting company to do? Discover a niche.
"Find one problem that businesses are having and knock the cover off it," said Juarez, who also counseled data center operators to target a certain size or type of business customer.
"Can you do it for everyone? Where are you best suited?," he asked. "If you try to do too much, you lose your niche and your costs get out of whack."
Murphy said cash preservation will be a crucial management skill in coming months, and said facility owners may need to change the way they think about their properties.
"There's a real estate element to the business, but the value is not in real estate," he said. "The focus is on square footage, but more important than square footage is focusing cash resources on building innovative solutions for customers."
Murphy warned that hosting and colocation providers will need to either become profitable or be scarfed up by larger providers, especially the Regional Bell Operating Companies (RBOCs).
"I've got a fundamental concern about the business model," said Murphy. " I'm concerned about what the RBOCs are going to do. If things don't change in 12 to 18 months, the RBOCs have an opportunity to own this space."

OTHER IMN CONFERENCE COVERAGE:
Navigating Through The Wreckage
Focus is on practical strategies for weathering the downturn

Analysts: Hosting Models Can Work
But pricing, financing are major challenges, and the RBOCs are lurking

Smaller Servers, Larger Loads
Ultradense server blades can pack racks - but how to cool them?

Overseas Markets Offer Opportunity
But perils await unwary providers, and partnering is critical

Meet-me Rooms Attracting Attention
Interconnection a major selling point for El Paso, other providers
.