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Hosted Applications Aren’t a Free Lunch

Renting business software can sound like a great deal, but it’s not always the cheapest, or most effective, answer to your software needs.

Hosted applications — renting the use of business software that runs in an outside service provider’s data center — can sound very good to small businesses. Businesses can be up and running fast with software that they might not be able to afford to buy, deploy, and/or manage as part of their own operations. In fact, Gartner research predicts that by 2006, 30 percent of small and medium-size businesses will choose an application service provider (ASP) to enable one or more of their enterprise resource planning (ERP), customer relationship management (CRM), and supply chain management (SCM) business processes. It sounds good, and it can be, but hosted applications aren’t the cheapest or most effective answer to every software need, and they don’t eliminate the need for strong in-house information systems.

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Here’s how hosted applications work:

  • Typically an ASP runs the application in their data center, which should be secure and reliable (most guarantee 99.999% availability, or no more than 5 minutes of system downtime per year).
  • You pay for the use of the software. Pricing schemes vary from yearly usage and support contracts — based on number of users, amount of data that will be stored, performance requirements, etc. — to “on-demand” services where the price is determined by actual application usage. The first model is more common today, but the second is expected by analysts to be the wave of the future as so-called “service-oriented architectures” make it possible for software applications to spontaneously collaborate on tasks. (For example, your e-commerce software could spontaneously call a security application to check the electronic ID of a buyer.)
  • The ASP may do some minimal customization or integration work to make the application fit your business processes and work with your internal information systems.
  • Your employees access the application, typically via the Internet from their desktop or laptop computer, or information from an application such as hosted e-commerce software may be sent directly to your in-house systems for processing.

Hosted applications have several benefits:

  • They can be set up and ready for use very quickly, often in a matter of days.
  • A hosted service may allow your business to benefit from sophisticated applications that you couldn’t afford to buy.
  • Someone else buys and maintains the software and manages the data center where the software runs. The service provider does application updates, security updates and other management on the host systems, so your staff can concentrate on more business-related work.

However, there are a number of things you should consider before outsourcing:

  • Access speed: An application is as good as your access to it. Having a wonderful hosted CRM application, for example, does no good if your customer still waits on the phone while your service representative waits for information to arrive over the Internet. Application service providers recommend at least 56kb/second access speed for every person accessing the hosted software. This means if you have 10 in-house users, you need a 560kb/second connection, the equivalent of half a T1 line, to ensure acceptable access speed to the hosted application. And that is over and above the bandwidth you need for other Internet access such as e-mail, Web browsing, e-commerce applications, VoIP, etc. Depending on local connections, quality of service, etc., T1 connections can cost from $350 to as much as $1,000 a month, so you have to figure that into the cost of your hosted applications.
  • Customization and integration needs: Hosted applications offer limited ability for customization to fit your business processes and for integration with your in-house information systems. Some providers are addressing this. For example, the wildly popular CRM service provider Salesforce.com recently debuted a new set of tools to help to customize its applications, but such customization and integration generally entail the same kind of consulting fees that you would pay to customize your own copy of an application.
  • ASP service quality and reliability: Proactive planning for growth and disaster recovery as well as consistent system management are requirements whether the information system runs inside your office or in someone else’s data center. Make sure the ASP you choose has a plan to grow their systems and maintain quality as their business grows. See that they have comprehensive backup and disaster recovery plans. While they will certainly claim 99.999% uptime, ask for references from long-time customers to make sure they can back up that claim.
  • Security requirements: When you outsource applications, your valuable data travels across the public Internet on its way to and from someone else’s vault. To prevent data theft and possible breach of your customers’ and partners’ privacy, you need to be sure that information is well protected every step of its journey. Sensitive data may need encryption or other protection in transit, and the hosted application needs to provide strong security so that no unauthorized person can log in over the Internet and access your business information. The ASP also needs to demonstrate tight network and physical security processes within their data center. (Spyware protection is no help if someone can walk in and steal a hard drive or backup tape). The bottom line: your most sensitive information might be safest within your own walls.
  • Cost tradeoffs: When you consider outsourcing a business application, ask yourself how many people will use it, how long will you need it, what is your projected growth in terms of users and data, and how often will the software need to be updated. If you buy an application and run it on your own servers, you pay for it once and you can control when the software and systems are changed or updated. When you outsource, you pay every month, and someone else controls updates that may affect your business. So before you outsource, you need to figure out what are the real costs when you add in possible T1 lines, software updates and disruption, etc. Gartner says, “an ASP solution can be the least costly option in the first year or two, but it can become more costly than on-premises alternatives in the third year and on for small and mid-size businesses that will continue to pay monthly software subscription fees.”

While hosted applications may avoid upfront capital investment, they are still a technology investment, which means they should be approached strategically, with an eye to long-term business goals. If the cost tradeoffs make sense and all other factors align, they are a fine choice for basic applications, applications without high data security requirements, or to try out new applications before implementing your own solution in-house. But hosted applications may not be the best answer for your most strategic application needs, and they should never be a substitute for having your own in-house technology infrastructure.