Web Services Boon for Customers, Not Investors

By Thor Olavsrud

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While Web services offer tangible benefits and ROI to customers, analysts say investors may find it harder to profit from the technology, especially as it eats into and commoditizes the traditional bread and butter markets of IT consultancies and systems integrators.

In his report, "Web services: Waiting for the next wave...while fighting the undertow," Deutsche Bank Securities analyst William Zinsmeister suggested, "We see few ways for investors to profit off this pending architecture shift -- margins tend to compress in markets that commoditize. We do not think Web services will spur new models or a new "pure-play" that will challenge the incumbent vendors. The massive build out waves behind applications, infrastructure, and data have already occurred. We think Web services simply increase the pace of software services commoditization. For technology investors, we think Web services will impact each component of the software and services value chain differently..."

Web services are a set of common standards and protocols used by software applications to connect to one another over networks -- whether the Internet or a corporate Intranet. The term also encompasses software application functionality that is enabled through the use of those common standards and protocols to make itself available for other applications.

"Web services are self-contained, self-describing, modular, computer applications that can be published to a directory, located, and invoked across the Web," Zinsmeister explained in his report.

The Benefits
Zinsmeister said Web services offer a number of benefits to users, including:

* The use of common standards allows software developers to spend more time developing business logic rather than application code, automating processes and cutting costs
* The need for specialized skills is relatively low, according to Zinsmeister, because training a programmer to transition from C++ to C# (in the case of .NET, Microsoft's Web services framework), or from Java to J2EE (the competing Web services framework supported by IBM, Sun Microsystems, BEA and others), is fairly easy
* It enables wide-spread code reuse and a reduction in integration costs because all interfaces use the same standards and can now understand each other, which means that application code functionality can be written once and then leveraged by multiple applications rather than being written into each application separately; this also lowers maintenance costs because a change to the underlying logic of the application code only needs to be changed in one application rather than all
* More rapid development
* The ability to move architectures to lower cost hardware and software
* The ability to extend the lifecycle of legacy systems by wrapping an application (or a specific component of business logic within an application) in Web services standards, allowing other applications to leverage the data or logic that resides within the legacy system.

Historically, business integration has been a time-consuming, complicated and expensive task, providing a lucrative market for consultancies and systems integrators.

"Every time the IT folks make a change, they have to change the overall process," Ronald Schmelzer, senior analyst with Web services research firm ZapThink, said in April. Schmelzer also believes systems integrators will find their models challenged by Web services.

As Annrai O'Tool, CEO of Cape Clear Software, notes in his paper, Web Service-Oriented Architecture -- The Best Solution to Business Integration, "Business integration (that is, the task of tying many information systems together to support a business process) has historically been an extremely complex, costly, and time-consuming task. Dogged by a lack of standards in terms of programming languages, operating systems, application interfaces, and networking protocols, the traditional ways of integrating many diverse applications have necessitated small armies of systems integrators and Byzantine technology."

He continued, "I would hazard a guess that many reading this article have sat in large rooms with walls covered in paper diagrams that depict possible flows among several applications and mock-ups of screen layouts, only to discover six months and several million dollars later that even getting your CRM system to synchronize data with SAP is proving to be a nightmare!"

Service-Oriented Process
But Web services provide an answer to that problem in the form of an infrastructure model that most analysts dub Service-Oriented Architecture (SOA), a collection of orchestrated services which communicate with each other. This enables a "Service-Oriented Process" approach. Service-Oriented Process is a separate abstraction layer for business process definition and execution that leverages the capabilities of SOA, giving businesses a flexible approach towards implementing architectures that promote business agility.

This approach depends upon businesses defining their business processes and then using those processes to define their IT infrastructures. The businesses can then expose those business processes as Web services which can be consumed by other services. The processes can even include key personnel. For instance, a purchase order process could require approval from a purchase manager before it completes fulfillment.

"By 'opening up silos of information' and transforming traditional applications into services that can be listed in registries and invoked real-time by other applications, Web services may return the market from packaged applications to more custom-developed solutions," Zinsmeister said. "Many proponents suggest Web services represents the impetus that will drive the software industry towards true component-based applications, or a real 'plug and play' model."

Trouble for Systems Integrators
But the ease of integration also means that IT consulting and systems integration firms may have trouble finding customers as companies decide to do the work in-house, according to Zinsmeister.

"We think customers will likely keep much of the work in-house," Zinsmeister said. "The skill-sets around Web services do not require most customers to go outside their own staffs -- the skill-set barriers are quite low. We think vendors' biggest competition will likely be the customers' internal IT organizations themselves."

In agreement with this point, Schmelzer said, "The business process is going to be in charge of IT. It's really going to apply some serious pressure on the integration vendors. Simply connecting systems together is not enough. If you've really implemented Service-Oriented Architecture correctly, you shouldn't need an integration system."

However, Zinsmeister suggested that these same vendors could benefit long-term in volume with a spike in demand for customized development. Still, if companies choose to do the work in-house, Zinsmeister suggested that Web services architecture could reduce the net addressable market for the IT consultancies.

"Without development, systems integrators may be limited to the business logic or intellectual property as the sole source of value from where to make money off Web services," he said. "Our concern here is twofold. First, the potential size of this business logic market opportunity is very unclear to us at this point, although we would venture to speculate it would be quite smaller than the application development component of software.

"Second, a value shift from development to IP could put additional burdens to the vendors in the need to create their own demand for their IP-based business logic. No longer can IT consultants simply "ride the wave" of innovation. Now they, along with software vendors, must 'create' it. Collectively, we envision limited growth opportunities."

But ZapThink Senior Analyst Jason Bloomberg isn't so sure. Bloomberg said that integration is indeed becoming commoditized and eventually software will just integrate out-of-the-box. But while integration itself will become relatively easy, today's IT consultancies and systems integrators will find new opportunities if they embrace the coming change.

"There's a lot of problems left to be solved," Bloomberg said. "There's going to continue to be investment opportunities in IT for a long time to come, but it's going to shift around. Investing in the old way of doing things isn't going to work."

Bloomberg said that although the integration aspect will be simplified by Web services, consultancies will still have their place in an SOA world. "That complexity is still there," he said. "SOAs are going to be hard to build. They're hard to build now and they're going to continue to be hard to get right. From the consulting perspective, there's still plenty of value that a consultant can add."

He said firms will have to answer a plethora of questions, from which services should be used to how they should be architected to what taxonomies or vocabularies should be put in place. Once they seek to open their services to partners, customers and members of their supply chains, they'll also have to answer questions about multi-company policy and authentication. "It's not like these opportunities are going away, they're just moving," Bloomberg said.

Zinsmeister also said the shift from development to business logic for IT consultancies would likely force them to shift their profit models from ones based on time and materials to a more traditional licensing approach.

"Over time, systems integrators could license or rent their solutions to customers," he said. "Perhaps we could also see some blending of the software and IT consultants' models."

A Boon for IT Outsourcing Vendors?
The picture is a little brighter for IT outsourcing vendors, according to Zinsmeister. "We currently believe the clearest value-add path from Web services lies with the lower-margin IT outsourcing vendors," he said. "We base this view on the premise that companies tend to outsource more as processes become more commoditized. Should demand for Web services become mainstream, we think it ultimately should expand the market for IT outsourcing -- these Web services themselves will be outsourced and managed by third-party providers. No longer will applications and middleware be technically proprietary -- and therefore their CIO owners will likely no longer view them as strategic. In some respects, Web services represent the real market opportunity behind the application service provider (ASP) model."

He added, "From an outsourcing perspective, the greatest revenue opportunity, therefore, could likely be from managing and hosting Web services, whether the code was developed internally or externally." He even said that gross margin yields off such contracts may be higher. "Because Web services in theory will be standardized, gross margin should be higher," he said. "This is in stark contrast to today's typical outsourcing contracts where oftentimes disparate architectures, applications, and infrastructures generally limit the scalability of the vendor."

Still, there is a potential downside, Zinsmeister said. One of the key benefits of the IT outsourcing model is the lack of client turnover because the deals tend not to be portable due to contracting terms and the opportunity costs associated with drafting a new request for proposals (RFP). "However, we wonder whether the standardization and further commoditization of these IT assts and processes may in fact diminish this customer 'stickiness?'" he said.

Bloomberg, though, noted that Web services is simply the interface to an application, not the application itself. This means that the services themselves are location-independent, but that doesn't necessarily mean the underlying software is portable. "It's not a question of services, it's a question of the underlying technologies." However, he also noted, "From a business perspective, it's going to become less and less important whether or not the technology is outsourced."