Report: Dim Future For Colocation
Yankee Group research says market will shift to managed services

July 12, 2001 -- New research from the Yankee Group foresees dramatic changes in the web hosting market, including a greatly diminished role for colocation services.
The report by analyst Andrew Efstathiou predicts that both colocation and network connectivity will become commoditized, with hosting providers competing on specialized managed services.
"Hosting has finally begun the drive toward fully managed services," Efstathiou said. "We believe this drive will ultimately result in the virtual elimination of colocation services.
"Colocation is a service that will continue to be offered and be used, but the revenue from that space isn't going to be nearly as significant as the profit from managed hosting," Efstathiou added. "Colocation not only doesn't provide as much revenue, but less profit as well."
The Yankee Group projects that the overall web hosting market will grow from $9 billion this year to $50 billion in 2005, but sees a substantial shift in the distribution of that revenue.
Colocation, which currently represents 40 percent of hosting revenues, will shrink to just 20 percent by 2005, according to Efstathiou. In the same period, managed hosting will grow from 35 percent of revenues to 55 percent.
Ggiven the projected growth of the overall market, the Yankee data actually suggests that total colocation revenues would rise from about $3.6 billion now to about $10 billion in 2005.
While hardly disappearing, colocation's growth pales compared to the explosive revenue projected for managed services, which will rise from $3 billion now to $27.5 billion by 2005, according to Yankee.
"Ultimately, we believe that successful hosting providers will be focused on managed hosting services, not physical plant,'' said Efstathiou. "Both colocation and network connectivity will become commoditized and not make a significant contribution to the future success of hosting vendors."
A factor in predictions of declining market share for colocation is the expertise needed to maintain a colocated server. While the machine resides in leased space, in-house technical staff are still required to configure the server and handle security and storage.
"On the part of the end-users, it's difficult to attract and retain the talent to manage and run an e-commerce operation," said Efstathiou. "From the customer perspective, in many cases it's easier to have managed hosting."
In the managed hosting model, the service provider hosts the server in a colocation facility, but also sells the customer web management services including security, bandwidth management, content distribution and storage solutions.
Analysts believe the resulting "plug-n-play" solution will be embraced by businesses hoping to simplify complex web operations through outsourcing. Service providers are planning to charge hefty fees for these services, resulting in improved profit margins.
To succeed, providers will need to specialize, according to the Yankee Group, which predicted that offerings will focus on "vertical" markets, with providers tailoring customized solutions for a particular industry.
"With the auto industry, you can imagine a hosting center focused on managing supply chains," said Efstathiou . "A different model may be one for the banking industry, where financial institutions collaborate and exchange data."
Customer demand for managed services is growing slowly, but Efstathiou expects that to change soon as companies upgrade their existing web sites.
"I think the natural break point is when you decide to re-architect and change your sites," said Efstathiou, who said companies sometimes review their hosting arrangements when they overhaul a site. "I think we're rapidly coming to that point."
The Yankee Group research also saw a future for hosting in shared web server space, an affordable option popular with the small business market.
On shared servers - sometimes known as "virtual servers" - dozens of customers' web content reside on a single machine, which is housed at a data center and maintained by a web hosting provider.
"There's a large market for this in small to medium-sized businesses," said Efstathiou. "It's profitable, and important to large providers, because of the importance of the small to medium-sized business market. I believe that over time, CIOs will be willing to migrate more apps from managed hosting to a shared hosting situation."