What do web application developers and web hosters have in common? An easy question. They both offer a hosted service, be it a calendar or a website. Both also compete in the same space, although that might now seem that obvious. An until recently, web application developers needed hosting providers to host their applications.

That is, until Amazon launched their Web Services. I’m a great fan of this collection of tools, which enable developers to use Amazon’s vast experience and technology to offer the most scalable and reliable applications in a hosted environment (for extensive reviews, go here and here). With their launch,  Amazon entered the hosting space, and should now also be considered a hosting provider of sorts. And that’s what I want to talk about, because hosting providers do not have an answer.

Caught in a Gap

Hosting providers traditionally have focused on offering websites, whether on a shared server, dedicated or virtualized. They can be split into two basic groups: large bulk hosters which rely on economies of scale and are more centered on either shared services or highly automatically provisioned dedicated services (the process of purposing a server and loading it with applications to fit the customer’s need). GoDaddy ranks as a good example of a leading bulk hoster, Rackspace is another, dominant in the dedicated space.

On the other end of the hosting spectrum, there are a number of niche players, offering either a generic hosting service to a specific vertical (like logistics companies, health care providers or such), or more complex services to a generic set of customers. The latter group tends to focus more on Software as a Service or SaaS, but not necessarily so. They can be defined in small as far as their customer base goes, but offering high-margin services, either because of the type of service, or the close, often personal relationship with their customers.

The rest, which is the vast majority of hosting service providers, sits in between, caught in Porter’s ‘Gap in the middle’, taken from his Generic strategies on competitiveness. They both lack the scale to compete on price, like the bulk hosters can, or the uniqueness that the niche players can offer. They simply offer everything that their neighbors have on offer, and often match their prices. The result is a large percentage of hosting providers struggling to compete, and in the long run to survive. This might not seem too apparent in many cases, but we only have the disproportional organic growth of the internet itself to thank, which is often many times higher in many markets than the churn rates.

The move towards Software as a Service

I touched on SaaS before, a concept that fits nicely with a company’s SOA strategy. I’ll dig in a bit to show how this concept, though in itself still in development, is a precursor to my storyline.

SaaS, the migration of applications from inhome deployments to data centers, from where they are served to company users over the internet and either terminal applications or browsers isn’t new. The first wave started around 1998, when ISVs (Independent Software Vendors) started to realize the potential of the internet and how a company network, on which their applications sat, could be replaced by the internet itself. Yet for many reasons it proved too soon. The cost of connectivity (compare the cost of a T1 in 1998 to the cost of a DSL line now), a lack of standards, and IT departments which weren’t really focused on cost-cutting, not to mention decision makers that weren’t ready to store sensitive data outside the company, all impeded that it took off back then.

Now things are very different. Connectivity has been commoditized, securtity issues have been dealt with, and the recession of 2001 have all contributed to SaaS being embraced this time around. ISVs all started looking at their applications (again), and needed a hosted version to compete with market leaders (as in the case of Salesforce.com which has had a tremendous impact on the adaptation of SaaS in the CRM business and beyond, from smaller independent vendors to heavyweights like Oracle, SAP and Microsoft).

At the same time, a number of hosting providers donned themselves the term ASP, or application service provider, but it’s not SaaS. Wikipedia’s entry on SaaS says it well:

The reason for moving away from the term ASP or Application service provider is that the ASP generation was merely traditional client-server applications with HTML frontends added as an afterthought. These applications were hosted by third-parties who ordinarily did not have application expertise, but were managed servers. Because the applications were not written as net-native applications, performance was poor and application updates were no better than self managed applications. By comparison, current net-native SaaS applications or independent portions are updated regularly, many daily.

This gradual shift in the terminologies also is a direct reflection of the change in the business requirements demanded by clients. The focus in SaaS is more on what the customer wants rather than what the vendor could give as was the case in an ASP.

Early SaaS approaches were application service providers (ASPs) who ran a turnkey application on behalf of their clients. But ASPs generally did not build the application themselves; rather, they took an off-the-shelf application (such as a messaging platform, an enterprise requirements planning tool, or a salesforce automation package) and ran it for customers.

And it clearly shows the threat coming from Web 2.0 (which I like to think of as a ‘mini-SaaS’) and SaaS: hosting providers stand the risk of being pushed back into commoditized services, namely power and space, and letting Web 2.0 and SaaS providers run away with the value.

Value Added Services

Think about it. Who’s sooner capable to offer a full range of services to a small business, the ISV who hosts their application and plugs into a wholesale program to offer website hosting and email? Or the hosting service provider, which already offers these low-value services, but would need to build its own applications? Both ISV and hosting provider would give you an opposite answer as to what the non-core value-added services is. So which is it?

In my opinion, the ISV, whether a one-person operation or a large multinational like Oracle, stands the best chance in the long run to win over a customer.

When you think about it, many hosting providers do offer their own applications, primarily the control panel or sitebuilding tools that they have developed inhome (though this is more and more becoming a thing of a past, because of cheap plug-and-play alternatives companies like SWsoft have on offer).

Conclusion

So what’s left to do for hosting providers? Should they sit back and let Amazon cater to every web developer out there, and be content with at least operating in an expanding market, allowing to -for now- push back the difficult decisions on how to get a competitive advantage in that overcrowded gap in the middle I mentioned before? The answer isn’t simple here. A lot will probably do nothing for now, instead trying to get as much critical mass until the moment arrives when the market growth isn’t that strong anymore. Many of them will fail, and will disappear.

Others will nichefy themselves, which is difficult coming from the middle. I will mean cost-cutting, layoffs and a reinventing of their marketing and sales strategies. Again, of those who opt to do this, many will fail (though in effect, less than those opting to compete long run with the price leaders).

And a few will retool themselves to become hybrid SaaS providers, getting smart Web 2.0 developers on board, offering some consumer brands along with clear hosted services for small businesses. They will build upon their inhome development skills, and act as incubators for budding developers -but not like Amazon does, who will become the GoDaddy for developers. These hosting providers will have partnerships, revenue shares and so on high on their agenda, to ensure that by solely hosting their apps, they will not set up a competitor in the long run.

These three options will play out whenever the market for hosting services matures. It’s not good strategy to wait and see -Amazon’s Web Services have already shown what will happen when that time comes.