ServerVault Case

Servervault is a company in the hosting industry located in the United States which has been in operation since December 1999. A hosting company provides its customers with physical space for servers and supporting services. Servervault chooses only to operate in the managed hosting section which gives more value-added services to customers.
ServerVault attracts Internet-reliant and security-savvy customers. It also provides end-to-end solutions to customers. Servervault differentiates itself from competitors by offering high level of security protection. It also has enough bandwidth and power supply to ensure the Internet access is always available. Servervault has three sources of revenue: one-time setup fees for new customers, monthly hosting fees and fees for additional value-added services. Although the variable cost of serving an additional customer is relatively low, it requires large funds to build facilities upfront. Recently, the president/CEO and CFO want to raise some capital for its expansion. The potential investors want to learn more about ServerVault’s projected cash needs to make the investment decision.
Macroeconomic analysis
Economic background
As it can be seen from Appendix A(1), the NASDAQ composite peaked at 5048.62 in March 2000 before dropped dramatically to 3205.11 in April. The major contributor to the loss is the internet bubble. The increasing stock prices over the last few years made some investors too confident in IT companies. However, the collapse of the bubble took place in 2000, when a lot of IT companies failed. As a result, the NASDAQ composite witnesses a huge loss in the stock market. Hence, it is a good opportunity for ServerVault to get more market share.
On the other hand, Appendix A(2) illustrates that the US GDP has kept growing during the last six years, which suggests that the loss may only occur in the IT sector. The growth in GDP brings more business capital spending. (Please see Appendix A(3)). Some of these capital spending may be used to hire third parties to strengthen firms’ IT departments. Therefore, it is a good news for ServerVault since it may have more customers in the future.
Social background
An analysis in social background will help ServerVault to determine what customer needs. The number of internet users worldwide was only about 30 million in 1995, but it increases to around 280 million in 2000. Please see Appendix B. The popularity of internet offers businesses a new way to advertise and sell their products. Nowadays, people like to shop online so that more and more companies need reliable internet servers to handle complex transactions. Since ServerVault specializes in this area, the increase in the number of internet users is definitely good.
Microeconomic analysis
Competitors
Competitors are a major threat to the business. Therefore, to gain some insights of competitors’ businesses can help ServerVault to determine where it stands in relation to the industry. According to the information from the Bureau of Labor Statistics, ServerVault faced intensive competition in 2000, as the number of establishments in the data processing and web hosting industry was approximately 28000. However, that number decreases by 46% to around 15000 in late 2011. (Appendix C(1)). As the demand for web hosting services has kept growing, during the 10-year period, some firms in the industry become very large while a lot of them failed.
In 2000, the leaders in the managed section of the web hosting industry were Digex, IMB and Data Return.
The major service provided by Digex is largely the same with the one offered by ServerVault. However, Digex also has revenues from value-added services including firewall management, stress testing, consulting services. It also provides computer hardware, software, network technology, and systems management necessary to customers. In the year of 2000, it had revenues of 168 million and a net loss of 143 million. As it can be seen from its balance sheet, it has huge investment in capital assets. Its property and equipment account for 77% of its total assets. (Please see Appendix C(2)).
IBM operates in five business segments. Web hosting services would fall in the system and technology segment, which provides clients with business applications requiring computing power and storage capabilities. The total number of signed strategic outsourcing contracts valued at more than $100 million increases from 24 in 1997 to 58 in 2000. In 2011, the system and technology segment had revenue of 20 billion with pre-tax income of 1.6 billion. (Please see Appendix C(3)).
Data return also offers ongoing maintenance of hardware and software, including content back-ups and system upgrades, in addition to its web hosting service. It has total revenue of $7.1 million and a net loss of $12 million in 2000. (Please see Appendix C(4)).
Customers
Customers are very important to ServerVault, because they are the source of revenue. Small companies usually have simple internet needs and can be satisfied by shared hosting services. Those who already owned and managed their own servers but lack a suitable space and a reliable internet connection are customers of the co-location segment. The customers in the managed section would be companies with significant internet presence and high volume e-commerce. E-commerce in the United States grows at a fast speed during the last decade. Please see Appendix D(1). Since each e-commerce company has the possibility to outsource their web host, the demand for managed web hosting service will also grow at a fast pace. In addition, globalization, deregulation, and technological innovation force companies to find outsourcers to get ready for the future. Please see Appendix D(2). Therefore, ServerVault can attract lots of customers with custom services that fit customers’ needs at reasonable cost.
Substitute
If there are many substitutes, the demand for the managed web hosting service will decline as customers are able to switch between different services. Therefore, it is important to determine if there are any substitutes to the managed web hosting industry.
To operate internet-based applications, companies only have two options. They can either outsource that work to a third party or do it by themselves. Outsourcing has several advantages. Firstly, companies should focus on the goods and services that they sell or provide. The time spend on developing internet-based application could be better spent to make their products and services more competitive. Secondly, there is financial advantage to outsource the work to a third party. Digex, one of the major competitors, spent around $170 million to purchase property and equipment. (Please see Appendix E). For many companies, it is a significant amount of cash flow. In addition, companies can cut the number of employees required in the IT department. Meanwhile, the outsourcing expense is tax deductible under tax law. Lastly, the technology used in the web hosting industry is usually far from clients’ core business area. It is not wise to spend time and money in this technology.
Suppliers
Since server is an important input to the business, the server price will have an impact on the profit. There is much competition in the server market, as the total number of the server manufacturer amounts to 14132 worldwide. The majority of them are located in China and other Asian countries. Please see Appendix F(1). However, IBM, HP, Dell, Oracle, Fujitsu have almost 90% of the total market share. Please see Appendix F(2). Therefore, it is likely that ServerVault will choose to buy servers from these manufacturers, and it needs to carefully monitor the market price to make wise purchase decision.
New entrants
To learn more about the possibility of new entrants is beneficial to ServerVault, because new entrants will have downward pressure on prices which may affect the earnings negatively. The major factor that will prevent new entrants to the industry will be labor shortage. Please see Appendix G. In 2000, the labor shortage of computer professionals may limit the growth of the IT industry. As college graduates prefer to work for large companies, newly-founded companies will find it very hard to hire suitable employees. Therefore, it is very unlikely that the web hosting industry will have many new entrants in the next a few years.

Appendix A
A(1)

Source: http://www.google.com/finance/historical?q=INDEXNASDAQ%3A.IXIC&histperiod=weekly&ei=cKBjULDdL4mQkwPTwwE

A(2)

Source: the raw data come from US Department of Commerce-Bureau of Economic Analysis http://www.bea.gov/national/index.htm#gdp A(3)
Business capital spending. U.S. corporations are primary purchasers of information technology, and they often require the help of computer services vendors in order to use it effectively. Therefore, any long-term decline in the level of business capital spending would result in fewer computers being set up and maintained and would have a negative impact on the computer services industry.
Figures for U.S. business capital spending (categorized as “nonresidential fixed investment”) are available quarterly from the Bureau of Economic Analysis. During the past few years, business spending has risen faster than the economy. In 1999, such spending was up 8.3% over 1998.
Source: http://www.netadvantage.standardandpoors.com.myaccess.library.utoronto.ca/NASApp/NetAdvantage/showIndustrySurvey.do?code=ccs&date=/ccs_0600/ccs_0600.htm

Appendix B

Source: http://www.netadvantage.standardandpoors.com.myaccess.library.utoronto.ca/NASApp/NetAdvantage/showIndustrySurvey.do?code=cox&date=/cox_0300/cox_0300.htm
Appendix C (1)

Source: http://www.bls.gov/ces/data.htm
Calculation: (28000-15000)/28000=0.46
C(2)
Co. is a provider of managed Web hosting services to businesses operating mission-critical, multi-functional Web sites. In addition, Co. offers Web hosting services to the rapidly growing number of application service providers, enabling them to more efficiently deliver their application services to their customers over the Internet. Co. also offers related value-added services, such as firewall management, stress testing and consulting services, including capacity and migration planning and database optimization. Co. services include providing the computer hardware, software, network technology, and systems management necessary to offer Co.'s customers comprehensive outsourced Web site and application hosting solutions. http://www.new.mergentonline.com.myaccess.library.utoronto.ca/companyfinancials.php?compnumber=90285 C(3)
International Business Machines operates in five business segments: global technology services, which provides information technology infrastructure services and business process services; global business services, which provides professional services and application management services; software, which consists of middleware software that enables clients to integrate systems, processes and applications, and operating systems software engines that run computers; systems and technology, which provides clients with business applications requiring computing power and storage capabilities; and global financing, which facilitates clients' acquisition of Co.'s systems, software and services. http://www.new.mergentonline.com.myaccess.library.utoronto.ca/companyfinancials.php?compnumber=4427 C(4)
Co. provides Microsoft-based Internet hosting services to businesses, web site developers, application service providers and other organizations. Co.'s advanced hosting services enable its' customers to establish and maintain e-commerce and other applications through which they can conduct transactions and manage information on a worldwide basis over the Internet. Co. provides management services for its' customers' hosting needs, including: consultation and recommendations on standardized system architecture; installation, configuration and stress testing of hardware and software; ongoing maintenance of hardware and software, including content back-ups and system upgrades; a broad array of system and network monitoring and reporting services; and technical support designed to respond to both simple and complex system issues. http://www.new.mergentonline.com.myaccess.library.utoronto.ca/companyfinancials.php?compnumber=98629 Appendix D(1)

Source: www.destevenwhite.com
D(2)
According to IDC, slightly more than half of all outsourcing worldwide occurs in the United States. Demand is being driven by globalization, privatization, deregulation, and technological innovation. These factors are leading to increased global competition, which is forcing companies to focus more on cost-cutting measures. However, companies aren’t using outsourcing just to cut costs and get out of trouble. Now they are also turning to outsourcers to prepare for the future — and to avoid trouble down the road.
Source: http://www.netadvantage.standardandpoors.com.myaccess.library.utoronto.ca/NASApp/NetAdvantage/showIndustrySurvey.do?code=ccs&date=/ccs_0600/ccs_0600.htm

Appendix E http://www.new.mergentonline.com.myaccess.library.utoronto.ca/companyfinancials.php?compnumber=90285 Appendix F(1) http://www.alibaba.com/trade/search?SearchText=SERVER&IndexArea=Products&fsb=y F(2) http://www.fool.com/investing/general/2011/03/12/server-market-share-the-strong-get-stronger.aspx Appendix G
However, a major impediment to sustained growth is the shortage in skilled technology labor. Computer professionals, including programmers and system designers, are in short supply. Computer and data processing added 8,000 jobs in March 2000, a rise of only 0.4% (or 4.8% on an annualized basis), representing a slowdown in the rate of growth from 1999. Over the next few years, demand for talented computer services professionals is expected to outstrip supply, leaving many positions unfilled overall.
Source: http://www.netadvantage.standardandpoors.com.myaccess.library.utoronto.ca/NASApp/NetAdvantage/showIndustrySurvey.do?code=ccs&date=/ccs_0600/ccs_0600.htm