A New Lease

Charles Warczak had one of those career make-or-break decisions that most CIOs face at least once. His company, Sunburst Hospitality, was being spun off from Choice Hotels International. Warczak's task was to create an IT infrastructure to ensure Sunburst's 87 hotels in 27 states keep accurate books and pay bills on time. Warczak could spend several million dollars to configure and install his own financial system or he could make a bolder move on a new concept: rent the application over the Web on a monthly basis. He opted to be bold.

Warczak, vice president of finance and systems who is responsible for IS at the Maryland-based company, is one of the first executives of a medium-size business (Sunburst pulls in $US114 million annually) to rent an enterprise financial application over the Web. He is among a small but rapidly growing number of executives who access software the same way companies acquire office space: leasing it for a monthly fee. The more comprehensive and complicated software - and thereby potentially the most expensive - presents the best argument for renting over the Web. That's why ERP, human resources and financial applications are prime rental candidates.

Renting applications over the Web, say some, can be a quick way to acquire top-of-the-line enterprise applications with a modest upfront cost. That's true especially for small and medium-size businesses that often don't have the resources to buy, implement and maintain their own software. The Web's ubiquity and ease of use give any company with an installed base of browsers the opportunity to rent enterprise applications. By 2001, 15 per cent to 20 per cent of packaged application software licences will be in the form of rentals, predicts Tom Gormley, an analyst with Forrester Research in Massachusetts, who has studied the application rental market. During the next five years, Forrester predicts that the market for application rentals over the Web will rise from near zero to $US6.4 billion. (As a point of comparison, Forrester reports that companies spent $US17 billion on consultants to implement ERP and other enterprise packaged applications in 1997.) Still, is renting over the Web really the wave of the future or just this week's flavour? Applications from vendors including PeopleSoft, J D Edwards, Great Plains Software and Oracle have been available for rent for less than a year, so renting is still a largely untested practice. Yet, with technology and corporate strategies changing faster every day, some companies may have to decide whether to rent or buy before a solid track record is established. Here's how several early adopters made their decision to rent over the Web and why one is holding off - at least for now.

Cost Concerns

For Sunburst's Warczak, the decision to rent or buy was relatively straight-forward. Warczak oversees IS for corporate-owned Comfort Inn, Quality Inn, Clarion Inn, Sleepway and EconoLodge hotels; he opted to rent primarily to avoid approximately $US1.5 million in upfront capital expenses. Since being spun off on January 1, Sunburst no longer can depend on the financial systems and IS department of Choice Hotels, its former parent company. Choice had already implemented PeopleSoft financials and Warczak wanted to take advantage of that experience. So Warczak huddled with Choice's IS and finance managers and extrapolated what it would cost Sunburst to build an infrastructure of its own.

After several weeks of meetings with Choice executives, consultants and vendors, Warczak figured he would have had to spend at least $US1 million on hardware, software and networking equipment. Then he would need to unbundle Sunburst's financial data from Choice's database. That was a complicated matter because Choice had encountered numerous bugs and sluggish performance using PeopleSoft with an Informix database. To avoid the same problems, Warczak wanted to move the data to an Oracle database. Warczak estimates the cost of extracting Sunburst's data from PeopleSoft and porting it to Oracle would be about $US500,000. In addition to the capital cost, ongoing annual labour to maintain the system would amount to an estimated $US500,000.

But having to spend a couple of million dollars just to set up a financial system would cut into profits immediately, not an appealing prospect for the nascent Sunburst. "Everything at the corporate office including IT is an overhead [expense]," Warczak says. "Our mission is to keep that overhead as low and as lean as possible." Warczak signed a five-year contract with Maryland-based USinternetworking that began on April 1. The outsourcer absorbed the costs for migrating the data as well as for the software licences and hardware. Neither USinternetworking nor Sunburst will divulge financial details, but the outsourcer says it charges from $US50,000 to $US200,000 for PeopleSoft rentals per month depending on the number of application modules used. Sunburst is using only the financial module, so "we are toward the low end of that range", Warczak says.

By determining the cost of building a system, Warczak is a step ahead of most IS managers. According to Forrester's Gormley, most companies don't know how much they spend on internal labour costs to upgrade and maintain particular applications. CIOs often grossly underestimate internal costs - sometimes by as much as 50 per cent - because costs are spread in many different areas. For example, CIOs may neglect to include a portion of data centre costs when figuring the price tag for implementing and maintaining applications. "Nobody could tell us what their ongoing costs were," says Gormley, who interviewed 10 Fortune 1000 companies for a report on how they manage their packaged application environments and the costs associated with them. The report was released in January 1998. Add to ongoing costs the price of signing on with application service providers (ASPs) - the companies that provide the integration services for rented applications. IBM Global Services, USinternetworking, Corio and Oracle are early entrants in the ASP market.

According to Gormley, a typical ASP charges $US500 per user per month for renting ERP systems.

Despite the difficulty, companies looking to rent as a way of saving money need to devise a credible cost estimate for the labour needed to implement and maintain applications. Consultants with expertise in IS accounting and auditing including Andersen Consulting LLP and Deloitte & Touche can help in this area, Gormley says.

Renting can also be a quick-fix solution to IS staffing woes. Warczak, for one, is relieved that he doesn't have to compete in the bidding war for PeopleSoft technical experts in the red-hot Washington, D C, job market.

USinternetworking, Warczak's outsourcer, already has experienced PeopleSoft technicians on its payroll. "We'd have a real tough time holding on to people who are experts in, say, the accounts payable module," Warczak says. "There's a lot of cost with high turnover. That's something we're not going to have to worry about." For some small companies, renting is the only feasible option for acquiring enterprise applications because building their own is too expensive. Gary Rainsberger, president of D A Rainsberger, a 10-person accounting firm based in Michigan, says renting software provides his company with a high level of functionality at an affordable price. Rainsberger rents a Great Plains Software accounting package from IBM Global Services. He figures it would have cost at least $US40,000 per year to hire an IS employee to maintain the package plus about $46,000 to buy software licences and upgrades. At $US300 per seat per month, Rainsberger is paying substantially less to rent the accounting package over the Web. With clients given the added convenience of access to the system via the Web, Rainsberger believes his company is gaining a customer service edge it couldn't otherwise afford. Renting the software also reduces IS headaches. "All that we have to do is learn about using the application," Rainsberger says. "We don't need to know how to maintain the servers." Without the software package, Rainsberger's accountants would have to wait weeks for bills and receipts to come in before they would notice a cash flow problem.

Who's in Control?

Even if renting is cheaper than buying, companies need to consider control issues before they take the rental route. Once a company cedes control of an application to an outside firm by renting, it often sacrifices the opportunity to make modifications to the software, warns Spence Wilcox, president of Team 2000, a Michigan-based systems integrator. Wilcox doesn't recommend renting key applications; with ASPs unlikely to know your business as well as you do, Wilcox contends it's better to retain the ability to modify them in-house.

Renting software isn't like buying it and having a consultancy tailor it for your specific needs. ASPs will tweak software for customers but they won't do heavy-duty customisation work as will an integrator hired to deploy a purchased application - at least not in the short time frame that is common with renting.

Implementing ERP packages with a systems integrator can take several years; renting such applications provides a viable alternative for companies looking for faster implementation times because most ASPs can get a rented application up and running in 6 to 10 weeks. Given that time frame, ASPs can't provide much customisation, so companies have to weigh the benefits of speed versus the limitations of going with off-the-shelf packages.

When outsourcing any critical IT function, it's important to agree on service and performance levels upfront. Many elements of an application rental agreement are similar to traditional outsourcing arrangements. A service level agreement for renting should contain guarantees for uptime, help desk response and remediation when problems arise. Gormley recommends that service level agreements include a policy to handle software upgrades. Companies should also spell out how often upgrades will occur and how quickly the vendor is expected to implement them.

Security Questions

Convenience or cost notwithstanding, some CIOs wouldn't be caught dead sending sensitive information over the Web. Dick Lefebvre, vice president of information technology for Simpson Industries, an auto parts manufacturer in Michigan, has outsourced the J D Edwards ERP system to IBM Global Services. But he's not using the Web to connect with IBM's service centre in New York state.

Instead, he's using a private leased line. No way, Lefebvre says, would he put an ERP system on the Web. Lefebvre is concerned that a competitor could capture information about part numbers, purchase orders and pricing and use that data to undermine Simpson's prices. Using a private leased line makes for a more secure connection than using the Web, but it's also about 10 times more expensive. A 56K leased line goes for $US1000 to $US2000 a month.

Telecommunications charges over the Web - including firewall installation and maintenance - run about $US100 to $US200 per month. Lefebvre says he would consider renting an accounting package over the Web though, because competitors wouldn't be able to glean much sensitive data from tables of accounting data.

Some firms believe the Web is safe for mission-critical applications. With multiple firewalls safeguarding servers and secure socket layer (SSL) encryption as standard in browsers, the Web is plenty secure, contends Cliff Kalinowski, vice president of iPEO, an outsourcer of human resources services such as payroll and benefits management. The San Francisco firm rents software that tracks payroll, benefits and personal data over the Web from Employease of Atlanta.

IPEO's 20 customers (most of whom are HR reps) access Employease software with password access and SSL. Employease does offer digital certificates as a further security measure, but Kalinowski figures that's unnecessary. "We want to make the application easy to use," he says. "If we were to add more security, like [digital certificates] we'd have to train our clients on it.

"That's an exercise Kalinowski feels isn't worth the effort.

Despite lingering concerns, experts say that many IS managers will soon join Sunburst's Warczak by concluding that renting applications over the Web is their best option for acquiring state-of-the-art computing functionality. And indeed, the benefits of renting over the Web are impressive: renting lets companies plug into enterprise software while avoiding the need to hire permanent IS staff and make large investments in hardware. Renting also allows companies to try part of an ERP package before committing to buy the whole package. And according to Forrester's Gormley, ASPs can get companies up and running in one-third to one-half the time required for typical implementations in which customers buy software. Some companies will even choose to rent as a quick and relatively painless alternative to remediating Y2K-bug-prone systems.

On the other hand, for early adopters such as Warczak, the question is, Will the renting concept work as advertised? As Warczak prepared for his rollout last month, he worried about keeping scores of hotels operating through a drastic transition. But then he'd surely worry anyway about the performance of applications that he bought. At least by renting, he didn't have to shell out $US1.5 million upfront.

Kind of Here, Mostly There

The ASP movement has gathered steam and Australian enterprises are keeping pace with their global counterparts in the uptake of the practice.

In April, Sydney-based accounting software specialist Solution 6 announced it would host SAP's R/3 applications over the Internet in a move designed to give the ERP giant greater access to the burgeoning small-to-medium size enterprise (SME) market. In June, the United Nations children's fund, UNICEF, signed up to pilot Solution 6's program.

The initial sweet spot for ASPs is in the SMEs space, where the resource demands of enterprise applications are often too difficult for small organisations.

An industry advocacy group, the ASP Industry Consortium, was formed in May, and it recently doubled its membership to more than 50 vendors and ASPs. Australian ASPs and vendors members include Solution 6, Mincom, MUA and Professional Advantage. Microsoft, Fujitsu, National Semiconductor and Progress Software have also joined the group. Meanwhile, Hewlett-Packard recently announced a complete company restructure revolving around what it calls "e-services" - hosted applications. Mincom officials said it already has several ASP clients from around the world.

Noticeable absentees from the consortium are software giants such as Oracle, SAP and PeopleSoft. While SAP's applications will be available through ASPs such as Solution 6 and Oracle has announced plans to host its applications via its existing channel partners, the licensing concessions required for the ASP model to succeed remain to filter through.

"None of the software vendors have fully endorsed the ASP model in terms of licensing," said a spokesperson for the ASP Consortium.

The change in the application delivery method from seat-based licensing to concurrent user licensing, driven by server-based computing, is yet to be embraced by the major software vendors, according to the consortium. However, the consortium believes that will happen in time.

- Ellen Cresswell