The ASP dilemma

- January 01, 2001



Sections:
Hosted design environment
Pricing schemes
Customer concerns
Two years ago, long before "ASP" (application service provider) became the acronym du jour , executives at Quickturn, a Cadence Design Systems Inc. company, saw an opportunity: Serve a wider group of customers by offering the company's verification hardware on a pay-as-you-go basis.

For a regular monthly charge, Quickturn would host its high-speed simulation acceleration machines for customers at its "verification center" in San Jose, CA. In this way, companies could escape the up-front investment of between $1 million and $10 million to buy the Rapid Prototyping System outright. The system models the behavior of a chip prior to manufacture.
There was just one problem: The sales guys weren't enthusiastic about the plan, which they saw as potentially cannibalizing direct sales. "They said, 'Why would anyone ever buy it if they can rent the equipment at one-third the acquisition cost?'" recalls George Zafiropoulos, vice president of marketing for Quickturn. To allay the sales staff's fears, Quickturn positioned its ASP offering-QuickCycles -as a way for companies to fill their peak capacity needs, rather than as a way to rent equipment without ever buying.
Much to their surprise, Quickturn executives soon found that more than 80% of the companies that rented the verification services ended up purchasing the equipment within six months after the end of the engagement. Although only 20% of Quickturn's revenues currently come from ASP fees, Zafiropoulos now says the model has enabled him to acquire customers who would otherwise be unreachable.

 
"If you do [the ASP model] right, you have the opportunity for a renewable revenue stream." -George Zafiropoulos, vice president of marketing for Quickturn, a Cadence company.
Quickturn was fashionably early to the ASP party, which is now in full swing in the electronics industry. The idea is easy to understand: Vendors make their products (originally software, but now expanding to hardware) or services available for delivery over the Internet on a pay-by-use basis. Customers escape the hassles of implementing and maintaining an application and pay nothing up-front.
What isn't as easy to comprehend is where the ASP industry is headed. According to Gartner Group Inc., Stamford, CT, 60% of today's 480 ASPs will disappear into bankruptcy by the end of 2001. (No less than Pandesic, the Intel Corp./SAP AG joint venture, was an early casualty.) By 2004, according to Gartner Group, only 20 of the original 480 will remain. But in the same report, Gartner forecasts the ASP market will grow to $25.3 billion by that year, up seven-fold from $3.6 billion this year. Another respected market research firm, AMR Research Inc. of Boston, is even more bullish about the business, estimating 1999 ASP revenues of almost $6 billion (see pie chart).
The ASP model in the electronics manufacturing industry is so young it's unclear whether it will prove viable over the long haul. "It's too early to tell whether the model will take off or not," says Rita Glover , president of EDA Today, a market research company in Kingman, AZ. Glover, however, is convinced the model will have a place even after the hype dies down, because it makes expensive technology accessible to small- and medium-size companies.


Hosted design environment
EDA suppliers are leading the charge of vendors adopting the ASP model for the electronics industry. EDA competitors Synopsys Inc. and Avant! Corp. teamed up last June to create DesignSphere Access (http://www.designsphere.com ), a hosted design environment that contains all the applications a company needs to design an integrated circuit. DesignSphere is an open environment that can work with EDA software from other vendors, according to Dave Burow , senior vice president and general manager of the DesignSphere Group for Synopsys in San Mateo, CA.
Synopsys rejected the notion of taking one of its applications, such as its Eaglei verification program, and offering it on a rental basis over the Web. Burow says that approach would not allow as much volume as they needed to make the joint venture a success.
In this case, speed-not cost-is the primary value proposition for the end customer. "We give them a much higher level of security and reliability than most of our customers [small- to medium-sized businesses] have in-house, at about half of what they're paying [now]," Burow says.
But as Zafiropoulos and Burow caution, the decision to go ASP should not be made lightly. Many cultural, technical and financial issues must be resolved in advance, says Bob O'Connor , president and CEO of Softrax Corp. , a business infrastructure software provider in Canton, MA.

How to account for revenue is one of the biggest issues. If a customer is paying a yearly subscription fee up-front, a company can't call the entire amount one-time revenue, but must spread it out over the year, according to accounting rules. If the independent software vendor (ISV) is accustomed to one-time license fees and intermittent upgrades, its financial systems may not be able to handle the shift in revenue recognition.It helps to adopt this model prior to becoming a public company. "If you're already public and moving to this model, you'll face the hurdle of trying to communicate to the marketplace the effects of these changing business models," says O'Connor.
That may be, but on August 1, 2000 publicly traded Synopsys took the plunge of recognizing all its revenue-whether from its ASP offering or straight-out software sales-over time. Burow says this will be key to smoothing out revenue peaks and valleys.
The predictability of the ASP revenue stream is one of the model's chief advantages, according to Ravi Mohan , general partner at Battery Ventures, a San Mateo, CA-based venture capital firm. Battery has provided funding to ASP ECCubed Inc. , Westborough, MA, among others. Says Mohan, "The subscription model will create a better and more stable company over the long term."
Underlying the question of how to account for revenue is the even more pressing question of whether the ASP model will be as profitable as the more traditional means of selling software and hardware. Surely, in the short term it isn't. The ASP assumes the up-front costs of implementation (including any necessary integration with other platforms), which can be hefty, while only reaping a percentage of its normal sale.
A SAMPLE OF EOEM ASP STRATEGIES
CompanyURLASP strategy/partnerships
EDA/CAD software vendors
Autodesk Inc.www.autodesk.comOffers AutoCAD 2000 via the ASP model (ASP offering outsourced to New Moon Systems Inc., San Jose, CA.).
Cadence Design Systems Inc.www.cadence.comOffers a variety of applications via ASP; Quickturn unit offers hosted, pay-as-you-go chip design verification services.
Mentor Graphics Inc.www.mentorgraphics.comMentor Graphics does not have an ASP offering for its own software; it plans to partner with third-party ASP providers in the near future.
Monterey Design Systems Inc.www.montereydesign.comMonterey Design offers Web delivery of its eDolphin software, but has opted not to use the ASP model.
Parametric Technology Corp.www.ptc.comIn partnership with NetIDEAS Inc., Mt. Laurel, NJ, PTC offers Windchill as a hosted application.
Synopsys Inc.www.synopsys.comSynopsys and Avant! Corp. offer DesignSphere Access, a virtual IC design shop, on a per-project basis.
Electronics hardware manufacturers
Altera Corp.www.altera.comAltera has elected not to offer the ASP model for its software products.
Hewlett-Packard Co.www.hp.comHP is partnering with many software companies to offer its computing power on a rental or ASP basis.
Sun Microsystems Inc.www.sun.comSun is partnering with many software companies to offer its computing power on a rental or ASP basis. Also offers newly acquired StarOffice software suite via a hosted model.
Xilinx Inc.www.xilinx.comXilinx does not have an ASP offering at this time.
SOURCE: ELECTRONIC BUSINESS

Jacques Benkoski , president and CEO of Monterey Design Systems Inc. , examined the possibility of offering his company's Dolphin EDA application via the ASP model but concluded that the prospect of profitability-in the short and long term-was not great. "It's amazingly expensive to become an ASP, to implement it and run it," he says, adding that it was going to cost his company several million dollars. "Unless you can leverage that investment in sales you wouldn't be making otherwise, you end up with a problem," says Benkoski from Monterey's headquarters in Sunnyvale, CA.However, Benkoski says he thought it would be business suicide to ignore the influence of the Internet on customer mindshare. So he decided to offer Web delivery of the Dolphin software suite. The software resides at a co-location (such as Hewlett-Packard Co. , which offers this service) and the customer has a 24x7 global license for the software, so all the customer sites can access the application at any time. The pricing is traditional-an up-front license fee of about $330,000 per enterprise, with about 18% in annual maintenance fees.
Altera Corp. , a San Jose, CA-based programmable logic device manufacturer, has so far opted not to host its software as an ASP. Altera managers examined the notion about a year ago, when the ASP craze hit in earnest, says Craig Leclair , director of Internet marketing, but concluded the model would not be economically feasible because the software was only $1,500 to $2,000 to buy outright. "Our development tools are cheap in the scheme of things," Leclair says. "To offer them on a per-use basis, I'm not sure it would be viable." If customers push hard for the model, Altera will revisit the concept, says Leclair.


Pricing schemes
Profitability is, of course, tied to how the ASP prices its services. A few years ago, ASPs liked to price their services based on customer revenues. But that turned out to be a career-limiting move in some cases. "Pandesic structured its service so that it would get a piece of its customers' revenues," says Dave Boulanger , service director for AMR Research. "But its primary market was dot-coms. Dot-coms don't have any revenues-especially two to three years ago when [Pandesic] started out."

 
"Our development tools are cheap in the scheme of things. To offer them on a per-use basis, I'm not sure it would be viable." - Craig Leclair, Altera's director of Internet marketing
Today, a much more workable pricing scheme is to charge customers based on the amount of server resources consumed-whether that is the number of concurrent users per month, per minute or per hour. All of these models are used, according to EDA Today's Glover. And it's quite common in these early days of the model for each pricing arrangement to be a separate negotiation, according to the customer's situation. Boulanger advises ASPs to reserve the right to review the pricing agreement at least twice a year to ensure it remains fair for both parties.

Sorting out the pricing model is difficult, says Quickturn's Zafiropoulos. "The finance organization, marketing and sales all need to come together to figure out the right price point. You have to come up with something that's attractive to the client, but also gives you the revenue growth you need," he says. "If you do it right, you have the opportunity for a renewable revenue stream."


Customer concerns
Vendors also need to consider that the ASP scenario can be a tough sell. Security is the top concern of companies looking to rent services over the Web. To counter this consideration, many ASPs offer customers delivery over either a virtual private network (VPN) on the Internet or via dedicated ISDN lines.
Customers also fear losing control over their business-critical data by allowing it to reside at a third party's premises, says Gisela Wilson, program director at International Data Corp., a market research firm in Framingham, MA. But the most serious worry, according to Wilson, is regarding the ASP's economic vitality. "They have to worry seriously about an ASP going out of business," she says. Most ASPs are venture-capital funded, and that cash machine can shut down abruptly.
Indeed, the Gartner Group study that predicts widespread ASP failures cautions the impact will be devastating, as each closure may cause a domino effect among its customers.
Quickturn felt it had no choice but to embrace that uncertainty when it started its QuickCycles service. Says Zafiropoulos, "Jumping on the bandwagon and not knowing what you're doing is a given. It's all a learning experience."
Hassle-free ASPs?
Once you've decided to use the application service provider model, the next question will be whether to build the ASP service offering yourself or outsource it. Author Lauren Gibbons Paul chatted recently with Scott Sandler, president and CEO of Novas Software Inc., an EDA vendor in San Jose, CA, about this important decision.
Lauren Paul: You recently decided to outsource the creation of your hosted nLint offering to Toolwire Inc., Santa Clara, CA (a third-party ASP for engineering tools). Why did you choose to outsource?

Scott Sandler: To offer the ASP model, you can partner with someone to provide the platform for your application or you can try to set it all up yourself. As a software vendor, we needed to find a partner. That was the only way we could do this. To do it yourself, you first need a place to put the servers-and we don't have that. Real estate in San Jose is ridiculous. Then, you [need] very large bandwidth coming into that facility, uninterruptible power, redundancy-the physical space has to be right for hosting massive servers. Then you have to have the servers themselves. Then you [need] security and partitioning between customers. Then you have to have software to do billing and keep track of things. For us to do it, it would have been insurmountable-hundreds of thousands of dollars at a minimum. We pay [Toolwire] a small fraction of this on a monthly basis. The elements of setting up the infrastructure needed to make the ASP model possible is outside the scope of our business. We're a software company, after all.
Q: When you outsource the hosting of your application, what effect does that have on customer support?
Sandler: It's still our product. It's sold and serviced by us. The customer clicks for support on our Web site or calls in to our call center. [The ASP model is] just an alternate delivery mechanism.
Q: What was the toughest thing about outsourcing the ASP offering?
Sandler: It's hard to figure out pricing. There's no good data on this. It's the very early days for this model. Toolwire helped us set the pricing model [$1,000 for 100 uses of the software].-L.G.P.
Lauren Gibbons Paul is a freelance writer and editor in Waban, MA, for Triangle Publishing Services Co. Write to her at laurenpaul@triangle-publishing.com.