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Feature: Opportunities for Application Service Providers in Cable Networks Capture New Revenue Streams
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The always on broadband access provided by cable networks offers operators the opportunity to be application service providers (ASPs). In part two of our series on the relevance of the ASP model to cable networks, we develop a business case built upon the service models and architectures introduced in part one.

Internet access for e-mail and Web browsing is currently driving initiatives to upgrade cable plants to IP-centric platforms. However, the flexibility and ubiquity of IP technologies give cable operators the opportunity to offer new innovative services not only to residential customers but also to telecommuters, small office, home office (SOHO), and medium business customers. One example is application rental services, where end-users remotely invoke features from applications running on network-centric server clusters (see Figure 1).

This network-centric service model simplifies end-user system requirements and maintenance. It provides cable operators the opportunity to offer application services that take advantage of the always on broadband access that cable networks offer. In this role, cable operators become ASPs.

Market trends

According to the Yankee Group, the ASP market will grow from $3.1 billion in 1999 to $14.2 billion in 2003, (see Figure 2). According to this forecast, Web hosting and e-commerce are the key revenue generators.

A market segment of interest is income-generating home offices. By the end of 2002, IDC expects over 30 million U.S. home-office households with someone running a business. About 8.2 million U.S. households will be equipped with cable modems, out of which 6.2 million are expected to be home offices. This represents more than 75 percent of the cable modem customer base.

One of the elements driving home-based businesses to access and have a presence on the Internet is that it serves as a low-cost conduit for revenue-generating opportunities such as e-commerce. Also, the Internet is quickly becoming a strategic portal for business information and research, especially for small businesses, which tend to have a higher percentage of knowledge workers. This type of customer is cost sensitive, prefers to deal with local service providers and expects high-quality customer service. The ASP service model may help cable operators satisfy those needs.

Business case assumptions

A business case built around a simple scenario is presented in Table 1. A cable operator providing traditional Internet access services to residential end-users via cable modem wants to become an ASP. In this scenario, the cable operator built a data center capable of supporting a total of 50,000 end-users (20,000 end-users subscribed to ASP services and the remaining 30,000 end-users subscribed to regular Internet access services).

Another option would be for the cable operator to have a third-party service provider host the data center. This option reduces up-front capital outlays and allows faster entry into the market. But, for the purposes of the business case presented here, it is assumed the cable operator builds its own data center. The rest of the assumptions used to build the business case are presented in Table 1.

The business case assumes that the cable operator offers a simple set of ASP applications. Basic human resource applications, financial management, collaborative computing, sales automation, groupware and e-mail all are offered as a service bundle.

In addition, a simple pricing plan is assumed based on flat user per seat, per month fees. More sophisticated billing schemes are needed to support usage-based pricing either at the application level or at the transaction level. Determining the correct level of billing granularity depends not only on current technological capabilities, but also on ASP business and service arrangements for the application frameworks.

ASP pricing models

Figure 3 shows how ASP pricing models may evolve over time. The diagram shows a shift towards subscription-based and transaction models and implies that pricing models eventually may rely less on traditional software licensing.

The ASP service model offers applications to thousands of users on a monthly subscription basis. This requires adapting application-licensing schemes to fit a dynamic recurring monthly fee model. One example is software licensing utilities enabling ASPs to provision applications for rental without incurring up-front license fees. The software licensing utility measures concurrent usage of application software, and the ASP makes monthly payments to application software vendors accordingly. This utility may also apply tiered discounts as the ASP’s customer base grows.

The flat-rate pricing plan used in this analysis is based upon application types. The pricing criteria takes into consideration application value and application configuration time. Other pricing plans are in use today, such as charging according to server type and configuration (shared vs. dedicated servers). This type of pricing plan may be broken down further into hardware and maintenance fees. Another example is charging according to end-user access rights to application data (read-only versus editing privileges).

Projected revenues

The ASP service model rests on a pricing structure that generates monthly recurring revenues independent of the pricing plan used. ASPs have opportunities to increase these revenues. For instance, many existing applications are being "ported" to network-hosted environments. In addition, new network-hosted applications are emerging, creating opportunities to expand service portfolios and offer professional services. In fact, the ASP service model allows ASPs to cross-sell solutions from other ASPs. The service model simplifies adding new end-users as well.

In this business case example, gross revenues will grow from $1.215 million in 2000 to $27.457 million in 2004 (see Figure 4). After the fifth year, gross revenue begins to decrease. This is because of the assumption that there were no plans to expand beyond the capacity of the single data center deployed initially, and that service pricing decreases as technology matures. This means that after five years of steady customer base growth, either new data center facilities need to be deployed or the capacity of the existing center must be expanded. This, of course, depends on the growth-rate profile assumed in the analysis.

Anticipated expenses

In terms of expenses, there are several elements that must be considered. One element is the cost of implementing data center facilities and an improved Internet protocol (IP) infrastructure. Storage costs are particularly important.

Another element is the cost of customizing application software. As mentioned before, customized software does not fit well with the one-to-many ASP service model. The time an ASP spends customizing an application for a customer is time that cannot be applied to serving the needs of other customers. Also, application customization may increase the time it takes to complete application software upgrades. Applications must be designed in ways that optimize their customization capabilities or at least expedite the creation of libraries of pre-customized application templates.

Other expenses include application delivery costs, application service trial costs, best practice implementation costs, the cost of integrating new applications into existing service bundles and information technology (IT) staff costs, such as hiring and training. In terms of IT staff costs, the expense is spread over a growing customer base, thus providing economies-of-scale benefits. IT utilization is "bursty" in nature when dedicated to one company. Once IT resources are shared among multiple customers, their utilization increases and maintains a more stable rate.

The total expense results for the business case are shown in Figure 5. Expenses reach $2.011 million and climb to $6.859 million in 2004. Again, after the fifth year, the expense growth rate slows down considerably, corresponding to the data center reaching its maximum capacity at that time.

Cash flow analysis

Figure 6 shows the results of the free cash-flow analysis of the business case. Again, after the fifth year, cash flow decreases, given the assumption that maximum capacity is reached at that point in the data center and there are no plans for additional growth. At the same time, annual service revenues keep decreasing while no additional investments are made. In a more realistic scenario, the cable operator may plan for growth of both the customer base and the service portfolio. Also, technological advances that will increase infrastructure capacity and enable more profitable emerging applications will occur.

Figure 7 shows cumulative discounted cash flow results of the business case. With an initial investment of $2 million, a relatively simple portfolio of application offerings and limited growth planned, the business case predicts more than $41 million in 10 years with the break-even point reached in less than three years.

The ASP service model and architecture provide cable operators the opportunity to differentiate from traditional Internet service providers (ISPs) and exploit their strengths in offering converged service bundles. This model moves application processing, security and quality of service (QoS) to the network and relays presentation functions to end-user terminals. Security and QoS treatments still are needed to guarantee proper delivery and application response times, but these may be provided in a more efficient and simpler way over the cable access network. End-user equipment gets simplified, which results in a reduction of truck rolls and overall maintenance support.

The ASP service model rests on a pricing structure that generates monthly recurring revenues. It creates opportunities to expand service portfolios, offer professional services and to cross-sell solutions from other ASPs.

There are some challenges, however, that need to be addressed. For instance, more sophisticated billing schemes are needed to support usage-based pricing. The level of billing granularity depends on technological capabilities, and the ASP business and service arrangements upon which application frameworks are implemented. Adapting application-licensing schemes to fit a dynamic recurring monthly fee model is another challenge. A third challenge is designing applications in ways that optimize their customization capabilities at reasonable costs.

Once these challenges are addressed, the ASP model will provide cable operators with additional revenue streams and the ability to attract a new segment of SOHO customers.

Pablo L. Martinez is solutions manager for Lucent Technologies’ Broadband Access Group. He may be reached at .

This article is reprinted with permission from the NCTA, and is based on a paper from the 2000 NCTA Technical Papers.

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