Contraction, Consolidation and Innovation to Define Web Hosting Sector

By Rawlson O'Neil King, theWHIR.com

January 10, 2002 -- (WEB HOST INDUSTRY REVIEW) -- The lack of economic stimulus from North American governments will concurrently spawn new waves of contraction, consolidation and innovation within the Web hosting sector. Contraction and consolidation has and will continue to occur due to the impact of the global economic slowdown, eventually leading the hosting sector to re-engage the small business Web hosting segment.

Embracing the fantastical predictions of the IT research consultancies within the late 1990s, many Web hosting firms engaged in a rollout of extensive and expensive Internet data center infrastructure, in an effort to capture a substantial proportion of the exponentially growing marketplace.

Such corporate strategy seemed sound, since aggregate hosting revenues were slated to reach $19.8 billion by 2004, according to IDC (idc.com). Economic conditions worldwide, however, were not stable, and led to a lack of both individual and institutional investor confidence. As a result, equity valuations declined, considerably lowering the market capitalization across the entire Web hosting industry.

With many complex Web hosting firms and their expansions financed exclusively through both debt and equity offerings on the open market, these economic conditions led to a cash crunch, which only worsened after the horrific terrorist attacks on the United States.

With the North American economy in decline since May 2001, most economists downgraded near-term growth prospects after September 11, concluding that macro-economic conditions were even weaker than they anticipated during the third and fourth quarters of 2001. With a sharp recovery now predicted for the second quarter of 2002, it is evident that many firms will have to restructure within the interim, in order to conserve cash flow and continue operations.

A stark example of contraction and consolidation of hosting operations occurred late in 2001, when the world's largest complex Web hosting firm in terms of market share, Exodus Communications (exodus.com), filed for bankruptcy protection, and sold off the bulk of its infrastructure investments to British telecommunication giant Cable & Wireless (cw.com).

Globix Corp. (globix.com), another complex hosting firm, is also in the midst of preliminary bankruptcy discussions and continues to scale back its data hosting operations.

Verio/NTT (verio.com), one of the oldest and largest complex and SME hosting providers, is also contracting its operations through the elimination of over half of its data centers and 20 per cent of its workforce.

Verado (verado.com), another struggling managed hosting provider also continued the trend by recently cutting 63 employees and selling off non-core operations.

With many economists, including those at the Bank of Montreal (bmo.com) now expecting growth to resume by only by mid-spring, industry participants can anticipate even more organizational and structural upheaval within the hosting sectors. Investors are now demanding that business strategies come into accord with the new economic reality: recession. This means that companies will scale back operations and workforces.

Hosting firms will also focus upon new methods to increase cash flow, reduce debt loads and increase profitability. Firms characterized by smart management will utilize technological innovation to quickly achieve these objectives.

While economists' forecasts for a second-quarter recovery were dependent upon monetary and fiscal stimulus from national governments, it is evident that many of these initiatives have been stymied at the legislative level.

With the stimulus package in the U.S. Senate stalled and with no demonstrative political will for IT investments or even economic stimulus from the federal government in Canada, it is apparent that hosting firms will not be able to depend upon new IT spending initiatives from government.

As a result, hosting companies have begun to invest in cost-saving technologies and strategies. These strategies include the use of intelligent Web traffic software and hardware such as blade servers that increase Internet data center profitability. Savvy hosting operations have also turned to new financial arrangements in order to cut-costs. Some have sold their infrastructure assets and lease those assets back in order to eliminate debt.

Others are building strong strategic relationships with other leading industry players so that they are not building out Fordist-like organizations with tremendous overhead costs. Smart hosting companies are also investing less human resources on in-house technology development, and more upon the quality of their service offerings.

Indeed, the most competently run hosting firms have recognized that the value they impart to their customers is of utmost importance to ensure their retention. For this reason, investors can expect the outsourced Web services sector to heighten its focus more upon its clientele, especially those that operate small and mid-sized enterprises.

Though shared and dedicated hosting environments have been relegated to the status of low-margin commodity in the wake of much more complex offerings in the recent past, a new study indicates that small businesses are still ready to invest in the outsourced Web site proposition.

According to a recent survey of 976 small and mid-sized enterprises (SMEs), 86 per cent have confidence in the viability of their operations and 67 per cent have confidence in the U.S. economy overall. The survey commissioned by leading small business Web host Homestead Technologies (homestead.com), also found that 77 per cent of the survey sample believes that a Web site is indispensable tool to small business, as both a marketing and e-business tool.

With more than 50 per cent of small businesses in the U.S. without a Web presence, and with a renewed focus on profitability, industry participants can expect to observe a marked difference in market focus. Due to a slower economy and a lack of corporate and government IT spending, hosting companies will once again diversify their offerings to include both large and small businesses in order to inject healthy revenue onto their balance sheets.

The renewed focus on low-margin hosting, a proven, solid revenue earner from our dot-com era past, might even spark a renaissance, creating a new generation of SME focused Web hosting giants.