Independent co-location providers overextended

Rawlson O'Neil King, theWHIR.com

May 25, 2000 -- (WEB HOST INDUSTRY REVIEW) --  The quest to capture dominant market share has overextended many industrial-strength, co-location providers.

As a result, many hosting and communication firms that run telco-class facilities have begun to scale back. In their exuberant attempt to rollout millions of square feet of co-location space, some companies have run themselves so ragged that they have had to seek bankruptcy protection from their creditors.

The tactical error that these firms committed was expanding too aggressively. In an attempt to capitalize on the growing demand for complex hosting services, companies such as PSINet (psi.net) and COLO.COM simply grew too big, too quickly.

Their business plans were based primarily on an exponentially growing market for Web hosting services. The revenue streams projected by a slew of the industry's most credible research houses hence captivated these firms.

IDC (idc.com), a prominent research firm forecasted that the U.S. hosting service market would reach $1 billion in 2000, bringing the entire sector to more than $1.8 billion US. The firm went on to project that the sector would increase by a factor of 10 through 2003.

Frost & Sullivan (frost.com) would estimate that the Web hosting marketplace would be worth more than $35 billion in the United States by 2005.

Forrester Research (forrester.com) would project that U.S. Web hosting revenue would reach $19.8 billion by 2004. Indeed, Forrester was so bullish on the hosting industry that it predicted in a May 2000 report that the "user's drive towards high-end, e-commerce sites coupled with vendors' focus on Web solutions would put hosting on a path to the stars."

Bear, Stearns & Co. Inc. (bearstearns.com) meanwhile was so optimistic that it noted that "Web hosting companies are experiencing robust growth from customers with larger average contract sizes" and believed that the market showed "no sign of abating anytime soon."

In their ravenous pursuit of this projected revenue, some complex Web hosting firms expanded tremendously, with their boardrooms adopting a "land grab" mentality. Those first to market with the most sophisticated services and largest network of data centers were thought to have the best chance at becoming successful.

For this reason, independent vendors such as PSINet, COLO.COM and Exodus Communications (exodus.com) began to rollout extensive and expensive networks of carrier-neutral facilities.

Unfortunately, these companies did not bet on the carriers themselves building their own facilities. Indeed, Level 3 (level3.com) would rollout more than 1.25 million square feet of co-location space worldwide that offers connectivity to its IP network. And Williams Communications Group Inc. (williamscommunications.com) announced plans to spend $1 billion U.S. over the next several years to build up its own network of dedicated data centers, expand its co-location facilities and scale up its IP network. The new capital will be utilized to construct and equip new and expanded data centers, in order to increase co-location space by nearly 700,000 square feet. Over the past two years, Williams has also constructed more than 1.25 million square feet of co-location facilities.

Similarly, other more traditional players looked to increase revenue by providing bandwidth and connectivity through data centers, which were built for their core business.

Cash-rich transnational telcos such as AT&T (att.com), Sprint (sprint.com), Cable & Wireless (cw.com) and Concert (concert.com) hence moved into the field. Even the most gargantuan of corporate players, IBM (ibm.com), began to offer industrial-strength co-location.

This situation inevitably put stress not only on the independent vendors, but also on the entire marketplace. While the price for co-location service increased, so did its availability.

According to the commercial real estate firm Grubb & Ellis, this situation is projected to push the vacancy rate for telecom facilities in the United States upward.

"In the short term, it appears that the large, established telecom companies such as Sprint, Qwest (qwest.com), Verizon (verizon.com) and a handful of others are waiting on the sidelines as upstart companies downsize or go out of business," states a research statement from Grubb & Ellis. "At some point, they are likely to enter the market to acquire telecom facilities and infrastructure at a fraction of the replacement cost."

With the economy in a downturn and with margins for co-location relatively low, usually at 10 to 20 per cent in comparison to the 50 per cent that is usually derived from hosting, most industry insiders realize that some of the overly ambitious co-location providers are bound to fail.

COLO.COM, which operates a network of 22 Internet data centers throughout the United States, has already filed for Chapter 11 bankruptcy protection, while PSINet's stock has dropped precipitously over the last year.

Watch these companies for they are candidates for the first wave of co-location failure and consolidation.

About the Author
Rawlson O'Neil King is a managing editor and analyst at the Web Host Industry Review. Before joining theWHIR, Mr. King was Director of Corporate Communications at WebHosting.Com. During his tenure at Canada's most successful Web host, he established ineedsupport.com, the first branded destination customer care site in the shared hosting industry. He has prior experience as an IT consultant who served non-profit organizations, government and private industry. He holds a Bachelor of Journalism degree from Carleton University. Mr. King's column appears in theWHIR weekly.