Managed services: The road to future profits

Sameer Padhye, Vice President, Worldwide Service Provider Line of Business, Customer Advocacy, Cisco Systems, Inc

Service providers and their business customers share the dilemma of controlling costs while increasing revenue. Market competition has brought traditional telecommunications services under pricing pressure, even as wireless, broadband access and cable telephony services cut into access line revenues. But the picture need not be bleak. For service providers, managed services--the next step in the evolution--hold the promise of creating additional revenue streams and the ability to simultaneously address customers' needs with new services.

Businesses today are looking for help for a wide range of communications technologies, from VPNs and IP telephony to network security and remote access. They are increasingly interested in outsourcing these and other advanced network requirements in order to reduce capital expenditures while increasing their focus on core competencies. According to Ovum predictions, the total global managed services market continues to see strong growth at a CAGR of 19% and will deliver revenues of $64.4bn by 2012. A majority of Fortune 1000 companies are currently using or considering managed services to expand the reach and capabilities of their networks.

Aside from the obvious advantage of developing new revenue sources, the evolution to managed services reveals an additional bonus for carriers because the equipment deployed and the expertise developed for one managed service can be used to launch other new services that use the same networking foundation. This "one network, many services" opportunity makes strong financial sense for a provider, but demands a network that has high availability and quality of service (QoS), as well as other features, because the managed services running on the network must support their customers' mission-critical applications.

The essential building block for such networks is the increasingly popular Multiprotocol Label Switching (MPLS) technology. Properly engineered, MPLS provides the QoS and reliability for an IP network to handle customers' data, voice and video requirements, thus enabling MPLS-based IP VPNs to efficiently and securely meet almost all customer requirements. And there is plenty of incentive for service providers to consider offering VPN services: According to Ovum, VPNs are expected to experience the greatest growth of all managed services by 2009, with the largest market of 53%. And there is more good news: a recent IDC survey shows that up to 30% of companies are willing to entrust service providers with the design, construction and management of their IP networks.

Although it has recently become an industry buzzword, "managed services" is not a new concept. Almost any type of network offering can be considered a managed service because all services, even the most basic connectivity-based ones, require some level of management. Managed services are viewed as a continuum and range from very basic levels of management of access services to complete "hands-off" outsourcing of network requirements. And as services become more complex, service providers gain greater opportunities for higher margins; the more sophisticated the management behind a service, the higher the value of a service provided to the customer.

The most basic level or "tier" of networking services is "connectivity," including transport. The next tier is "provisioned services," which, in addition to managed CPE, also includes design, installation and monitoring of a service. The third tier is "integrated services," which can be selectively tailored to customer needs and includes bundled services and partner applications wrapped together with other specialized offerings. The most complex tier consists of customized services--which encompasses services in the other tiers as well as consultation for tailored networking services--and applications integration on a customer-specific basis.

For service providers, the third tier--integrated services--offers the greatest market opportunity: the so-called "sweet spot." Integrated services provide an opportunity for selling a differentiated offering, while also allowing network operators access to a large demand base, thus justifying the costs of their networking investments. Meanwhile, connectivity services will continue to become more commoditized, with fully customized services requiring massive investment and customer-specific tailoring, thus making them ill-suited to the service provider business model and relegating them primarily to the realm of systems integrators.

The managed services umbrella covers such offerings as IP telephony, wired and wireless LANs, content delivery, data hosting, VPNs, metro Ethernet and storage. Within each of these categories, network operators will find a variety of options. Managed services and associated bundled offerings can include particular network functions, such as security to end-to-end design, deployment and maintenance of LANs and WANs. Managed security services alone might include firewall management, intrusion detection, virus protection, Web site security assessments, 24-hour monitoring, applet scanning, content inspection and URL blocking. Such a range of options within managed services permits providers to not only differentiate their offerings from competitors but also to better tailor them to meet the needs of both specific customers and the general market.

Businesses are turning to managed services for both long-term strategic and short-term tactical considerations. Managed services allow a company to focus on core business issues while out-tasking to experts the operational details of the network. Managed services give companies access to the world-class capabilities of service providers that otherwise would not be feasible in house. By outsourcing its network requirements, a company avoids onerous capital expenditures while also sharing the risk of new technologies with the service provider. Most significantly, because of economies of scale, service providers can offer managed services to customers for much less than it would cost them to run these same services on their own.

Clearly, the value of managed services for end customers lies in cost savings. A managed VPN can, in our view, shave 27% from the cost of building it in-house when spending on IT personnel, hardware, and software is considered. Likewise, we estimate that savings on managed security can be as much as 75% compared to customers providing these capabilities on their own. At the same time, managed services free customers to reallocate IT resources from routine tasks such as monitoring routers, responding to help-desk inquiries and resolving user problems to such strategic objectives as QoS, employee mobility and new technology integration. Further, managed services come with service-level agreements (SLAs) that can be used to get priority handling in the event of outages, and so reduce the average repair time.

The bottom line for many customers--from small businesses to large enterprises that might have multiple remote sites for which a dedicated staff would be impractical--is that managed services tip the decision to buy as opposed to build. This plays to businesses' three main concerns: protection, profitability and productivity. They are evaluating their WANs and looking for ways to consolidate voice, data, and video networks as a means to enable collaboration and lower costs; to move to distributed, regionalized data centers for increased productivity and application availability; to achieve any-to-any connectivity for increased productivity among geographically dispersed locations; and to secure connectivity to teleworkers, partners and other entities requiring access to the corporate network from outside the LAN or WAN.

Five key attributes repeatedly surface in questions raised by customers looking for better performance and value from their networks. They cite high availability, security, QoS, multicast capability and comprehensive management products and services as top network considerations. An IP MPLS network can meet all of these requirements.

MPLS is already the preferred choice by the more than 200 leading telecommunications companies that we've worked with. For example, with MPLS, AT&T is offering 17 different managed services to address varying customer needs via a single, converged network. Telia Denmark is taking advantage of the time-to-market capabilities its MPLS network provides by deploying services in less than 90 days. Bell Canada has found its MPLS network so flexible that it is able to offer bandwidth on demand for voice, data, and video traffic. Bell Canada is supporting these services with the end-to-end QoS and reliability essential for mission-critical operations such as telerobotic surgery performed by a surgeon in a large hospital on a patient in a smaller medical facility hundreds of miles away. BellSouth, British Telecom, SBC, Verizon and many other carriers are also pursuing MPLS as the foundation for their managed services.

An IP VPN running over an MPLS network can serve as the foundation for delivering a wide variety of emerging IP-based services over the entire 56-kbps to 40-Gbps range. As a single, all-purpose network for voice, data, and video applications, MPLS lowers operational cost through convergence while IP VPNs eliminate engineering overhead as well as path and route management of hub-and-spoke interconnections. Using the intelligence of CPE devices, the data, signal and management paths between the CPE and the network make it relatively simple for service providers to activate services such as VoIP or firewalls. MPLS also serves as the glue to combine different access technologies into a single VPN offering.

Small and medium-sized businesses (SMBs) in particular present a huge pool of opportunity for service providers. SMB segment accounted for 51% of the managed service market in 2006 and is expected to grow 25% annually through 2009. By taking advantage of IP VPNs, service providers can offer SMBs a range of services-from IP telephony, VoIP, managed Internet gateway, managed router and managed LAN at a much lower cost than what the customer would pay to deploy these services in-house. Our research shows that, for a customer with 2000 employees and 20 sites, offering a handful of services (such as managed LAN, VPN, managed router, firewall and IP telephony) can triple service provider revenues, thus offsetting the trend of decreased access revenues.

Aside from tapping additional revenue streams from new services, managed services make existing customers more valuable for service providers. Customers who gain the value-added benefits of managed services are more likely to become loyal customers and purchase additional features from their provider. There is also ample evidence of a strong correlation between the number of services a customer subscribes to from a particular provider and a lower level of churn for the provider. For example, the addition of just one more service to a subscriber can lower churn upwards of 30%, which can result in significant savings in operations, sales, and marketing costs to the service provider. And the more entrenched a service provider becomes in a customer's network, the more complex it is for the customer to disconnect from the service provider. This translates into longer customer relationships and increased customer value. Service providers need not begin with a full range of services; they can, for example, begin by offering VPN, firewall and managed router services, and later augment these with managed LAN and IP telephony services.

The real value of managed services has everything to do with the end customers' business processes rather than the underlying technology or delivery systems. Technology wars are old hat. For both SMBs and enterprise businesses, the network cost model is changing from an asset- and liability-based model to a utility-based one. End users now view network services as on par with other utilities, such as power and water that keep the business running; so the key for the service provider is to differentiate its offerings by best matching its services to the complex requirements of its customers. Service providers have plenty of incentive: Global managed service revenues are expected to reach $42.4bn by 2009 at 20% CAGR

A way to effectively target this market opportunity and transition to a managed services-focused business model is to partner with an IP vendor. In addition to having a broad IP portfolio, the IP vendor's extensive relationships with enterprises and SMBs can be tapped by the network operator for assistance in service development, marketing, and sales. The vendor can also provide planning, design, implementation and operational services, as well as expertise to optimize the IP network. Such a partnership will help the service provider best address end-customers' needs, ease the rollout of managed services, and accelerate the time to realizing new revenue.

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