The biggest challenge for the new crop of ASPs will be attracting big customers. NetLedger doesn’t even try. It’s meant for companies with less than 100 employees. Salesforce is aiming higher, but so far its largest customer has just 300 users of the service. Are these upstarts going to snatch away giant business software projects? Not yet. "Maybe in a few years I would consider working with them," says Nick Amin, vice-president of information systems at Cigna in Philadelphia. "They don’t have all the capabilities that I’d need at this point"—such as sophisticated risk-analysis tools.

That’s already starting to change. The upstarts are quickly adding such features as sales forecasting. And their deals are getting bigger, too. Employease, an Atlanta-based human-resources service, has seen its average customer size increase from 96 employees to 441 employees during 2000. "I’m supporting 500 people with Employease," says Reed Vickerman, vice-president of information technology at Copper Mountain Networks in California. "Adding more would just be a matter of clicking a button."

The software giants can’t turn on a dime like the upstarts, but they’re quickly becoming forces to reckon with. The furthest along: Intuit, the $1 billion maker of financial and tax software for small businesses and consumers. Already, Intuit is reaping more than 20% of its revenues from online services. Every piece of packaged Intuit software, from the QuickBooks accounting program to TurboTax, has an online counterpart.

While Intuit has the jump on its brethren, other major software makers vow to excel at delivering their software as services. Software heavyweights such as SAP, Oracle, and PeopleSoft have a distinct advantage over the first-generation ASPs when it comes to profit margins. They don’t have to buy somebody else’s software—they make it themselves. In the past year, Oracle doubled, to 100, the number of customers using its finance, manufacturing, and customer-service applications online. With SAP, 16 ASPs are hosting its applications for 150 customers.

Microsoft is going at this market a bit differently. While it offers its Office desktop applications to customers through a handful of hosting services, its main goal is to provide a software platform for corporations and ASPs to build upon—the so-called .Net technology. As part of Microsoft’s $50 million investment in USi last fall, the upstart agreed to offer customers services based on Microsoft’s technology. But Microsoft faces stiff competition from Sun Microsystems and Oracle, which also supply foundation technologies for Net services. Upstarts such as salesforce.com and NetLedger built their systems on Sun’s heavy-duty Unix operating system and use Oracle databases. Would they ever retool for Microsoft? "No way," says NetLedger CEO Evan Goldberg. "We don’t think Microsoft software is ready for an online service."

Making the transition from the traditional software business to services won’t be a snap for the established giants. They’ve got to retool their technologies to run smoothly on the Web. And they’ve got to tinker with their business models without upsetting quarterly earnings—shifting from their dependency on huge, up-front license payments to monthly fees.

Rather than mess with what’s working well, some of the established software companies are opting out of the ASP business—at least, for the time being. Consider Check Point Software Technologies, which sells firewall software that protects corporations from intrusions by thieves or hackers. It’s deeply committed to a network of 1,000 distributors that handled 90% of its $425 million in revenues last year. Offer services directly to customers?

Shwed, however, may be in the minority. Most established companies are gung-ho for offering software services. "If software companies don’t do this—maybe not today but somewhere down the line—they are going to die," says Tim Chou, president of Oracle Business OnLine. That may be too dire a prediction. However, given the volatility of the software business these days, it makes sense for them to at least hedge their bets.

Jim Kerstetter with Jay Greene in Seattle—BusinessWeek