Hosted Services - Dangerous Waters Ahead?Hosted Services - Dangerous Waters Ahead?

We would be well-served to learn from lessons of the past and include an evaluation of a provider's financial stability during the buying process for hosted services.

The growth predictions and enthusiasm of today's hosted services marketplace reminds me of the CLEC (Competitive Local Exchange Carrier) environment in the late 1990s. New companies were springing up everywhere, offering local and long distance services as a result of the deregulation mandated by the Telecommunications Act of 1996. The legislation had the goal "... to let anyone enter any communications business -- to let any communications business compete in any market against any other."

New offerings hit the market, and the landscape became cluttered as new and existing companies competed for customers. Many companies began putting fiber in the ground and hardware in Central Offices to build their own networks. Sound familiar? Today I did a Google search on "Hosted VOIP" and there were over 9 million results.

As the CLEC business moved from growth to maturity, sales peaked as the market became saturated and competition grew increasingly fierce. Prices and then profits began to decline. Companies that had financially overextended themselves began to fail, and some customers were faced with the problem of finding a new service provider on short notice. We advised our clients back then to pay as much attention to a prospective provider's financial statements as they did to the pricing and services being offered.

I don't think we are out of the growth phase of the hosted services market yet; however, we would be well-served to remember the past and include an evaluation of a provider's financial stability as an important component of the buying process for hosted services.

The financial model for hosted services is appealing - at least in part - to organizations that do not want to make a significant capital investment in new technology upfront. Instead, they pay for services over time. This means that the hosted provider is the one who incurs those large capital expenses. They spend a lot of money with the intention of making it back over time using financial models that assume a certain amount of revenue per seat.

Most hosted VOIP offerings that I have seen in the past have been in the $20 to $25 per user/per month range. However, Lync Online Plan 2 is $7 per user/per month. Admittedly, the Lync service is not a fully serviceable voice offering (you can only call people who are using Lync or Skype), and it doesn't include Enterprise Voice Functionality (Malicious Call Trace, E911, Call Park). However, this price point may well spark massive competition and crush the profits of companies whose financial models assumed higher revenue figures. These companies still must cover ongoing expenses, but revenues are delayed and may be decreasing. In the late 1990s, many CLECs reached this point, ran out of funds and closed their doors. Competitors bought their assets for pennies on the dollar.

The parallels are numerous when comparing the CLEC mania and today's hosted market. Both have changed the marketplace and our expectations. But it is only reasonable to expect that the hosted marketplace will mature, and that there will be a number of competitors that do not survive.

How can you protect yourself in this environment?
First, be aware that the financial stability of your hosted provider is as important to evaluate as the services and pricing being offered. Companies that have been in the hosted business longer will have had more opportunity to write down their initial capital expenses; those newer to the market have more expenses to bear.

Second, be aware of the ways hosted providers have available to cut costs. Their cost components consist of a data center environment (most companies rent this instead of building it) plus computing, storage, and communication/network resources. Amazon Web Services and Google Compute Cloud are engaged in what appears to be a price war; the scale of their operations allows them to do this while smaller companies simply cannot. It is entirely likely that some hosted providers may try to cut costs by moving their services to these large providers. In fact, Interactive Intelligence recently announced their new Pure Cloud offering that is based on Amazon Web Services.

Third, have a backup plan that addresses the scenario of a failure in your hosted environment. Include documentation of your setup and programming, and investigate the feasibility of having a second provider already determined or even in place with some minimal services so that you can transition if needed.

The industry press is full of predictions of massive growth in the cloud marketplace, and it is easy to be lulled into complacency and to forget the lessons of the past. As you would when dealing with any other change, let good sense prevail.

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