Many have said good service is hard to find, but according to the Yankee Group's latest take on the Web hosting market, service may soon be hard to avoid.

The Boston-based consulting firm has predicted that within the next 12 to 24 months, the growth of and demand for fully managed hosting services will push simpler co-location services to the brink of extinction.

In its report, Managed Hosting Centers: Focus on Service, Not Space, Yankee projects that managed hosting revenues will grow from $3.15 billion in 2001 to $27.5 billion in 2005.

"I don't believe there were any profits in that space to being with," said Efstathiou. "What differentiates these companies is an ability to offer managed services, not an ability to offer real estate."

Profits dry up

In fact, so much real estate is now available in data centers, since fewer dot-com companies are alive to fill the empty racks, providers desperate to fill the space have dropped prices to the point where co-location alone is hardly profitable.

Bandwidth access costs, another past source of revenue for co-location providers, are also declining as availability increases, said Efstathiou, which further erodes profit potential for Web hosters.

Now, Efstathiou said, hosting providers hope to differentiate themselves - and increase profits - through managed services offerings.

"The prime reason why that's the big value add is it's so difficult to do well," he said, because of the complexity involved and the employee skills that are required. "If you do it well you can make a lot of money doing it and achieve a high level of customer retention."

Efstathiou said Exodus Communications, Inc., a long time leader in the co-location space, was one of several companies that originally intended to focus on managed services but became too caught up in building data centers back when demand for collocation space was still skyrocketing.

Efstathiou said Exodus and other companies in similar positions such as Digex Inc., Genuity Inc., and OptiGlobe Communications Inc. , are likely to survive, either on their own or as an acquisition candidate. But to do so they must make managed services a priority by not only building out their services capabilities but also by marketing them to customers.

Efstathiou said management service providers, such as InteQ Corp. and SilverBack Technologies Inc., are unlikely to swoop in and acquire troubled hosting providers even though managed services are their core products. He said it would simply be too expensive for them to do so.

Customers will switch gradually

But will customers come to prefer managed services over co-location, especially when it comes to turning over the reigns of critical hardware and applications? Efstathiou said customer demand will increase gradually.

"Just as outsourcing has gained mind share and market share because people have, to some degree, seen the model works, and they can get higher service (levels) with lower cost. I think the same thing will happen with managed services in the data centers," said Efstathiou.

Also, because the migration from co-location to managed hosting is likely to happen gradually, Efstathiou said there is no reason for customers to worry that their co-location providers would suddenly transform their business models overnight. He said hosting providers would eventually specialize in services for specific industries, but if a vendor is providing good service, there is no reason to scramble to find a new provider.

Efstathiou's report is available through the Yankee Group's E-Sourcing Strategies research and consulting practice, which is a subscription service.