Business Models Must Become Sustainable

By Rawlson O'Neil King, theWHIR.com

March 1, 2002 -- (WEB HOST INDUSTRY REVIEW) -- Exuberant capital markets are no longer the hallmark of high-tech in general and the hosting sector in particular. The markets have proven that they can only sustain rational growth and have therefore undergone a correction. The result is that stock prices have begun to reflect the true worth of technology firms, in terms of both near-term profit estimates and long-term overall outlook.

Financiers are no longer interested in backing multitudes of start-ups with optimistic business models. Institutional investors will only pursue companies that employ rational business strategies and have the potential to capture a substantial, existing consumer marketplace. As such, investment banks will now only invest where there is a definable marketplace with addressable needs.

Web hosting, of course, will still remain a strong addressable marketplace. The sector, which according to Tier 1 Research posted $5.7 billion in revenue in 2001, still holds compelling opportunities in the years ahead. Companies however will need to adjust their strategies in order to effectively capture both a proportion of the growing marketplace and the concomitant investment dollars needed to develop their business.

How will they accomplish this?

Firstly, firms will need to practice what they preach. Hosting providers make their money by convincing their clientele to outsource their information technology infrastructure. While many firms made an excellent case that Fortune 500 companies should focus on their core competencies rather than on their hosting infrastructure, these firms in turn did not outsource costly and substantive portions of their own business operations.

The result has been bankruptcy and massive restructuring for many providers.

Utilizing capital from the exuberant markets of the recent past, many companies attempted to structure their businesses using Fordist economic principles. Spending tremendous amounts of dollars, these firms attempted to provide full-service Web hosting under one organizational umbrella by deploying nationwide and sometime worldwide networks of data centers and Internet connectivity.

Predictably, the costs of these firms rose exponentially, surpassing the amount of revenue that the entire sector generated in 2001. As economic conditions began to deteriorate, complex Web hosting firms with huge overhead costs simply ran out of cash and failed.

Such failure could have been avoided if hosting service providers had i) made reasonable and rational infrastructure outlays and ii) outsourced the expense of redundancy to other providers.

Further, many companies have now realized, at the demand of their investors, that "just-in-time" methods are just as applicable to high technology as they are to any other business. Hosting firms added to their misery by attempting to offer entire suites of enhanced services to their clientele, without any demonstrated mass-market demand. Service providers could have satisfied the special requirements of their clientele by simply outsourcing the small demand for enhanced services to other service providers, rather than building out entire new divisions.

With the economy presently in a slump, it will be increasingly necessary for providers to ensure that they keep enough cash on hand to maintain services and make strategic investments. They will only achieve this objective if they make a profit or have a solid, evolving plan in order to turn a profit in the near future.

Business models from now on must be sustainable, because capital markets will not be as generous as in the past. This means that hosting providers will need to price their products and services appropriately in order to build cash flow and become revenue positive.