State of the Hosting Industry – 2014

Earlier this week, the hosting industry gathered in Miami for what is probably its most significant annual meeting of the minds. HostingCon is not an event that the likes of Amazon, Microsoft, and Google attend, but it is the place where the rest of the industry meets to freely discuss the state of market opportunities and exchange ideas on strategies to address them.

This year there were three major takeaways that you can use in your calculus as either a consumer or provider of hosting services.

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Tapering Growth – An Opportunity

There was a noticeable calmness in the air this year along with a general sense that annual growth rates in the hosting industry have seen their high water mark. Philbert Shih presented his usual slide deck chocked full of industry stats, and clearly, players both large and small are experiencing slowing growth (< 25%) in most sectors. Interestingly, cross-sector buying (e.g. colo plus managed services) tend to be growing faster. CEO’s on the panel sessions seemed to feel, almost unamiously, that the so-called “big-and-easy money” has been earned out of the market, and that while great opportunity still exists, it is now to be found in focusing on niches.

For consumers, this means the non-commodity hosting providers should be coming toward you in terms of solutions more completely tailored to your particular needs, but not necessarily at lower prices. Expecting to begin finding hosting companies who more deeply understand your particular industry and have solutions aimed at giving you a great experience. But also expect to pay accordingly.

For hosters, this means picking a niche and focusing hard on it. Continuing on as a generalist will become increasingly more difficult as time goes on – there simply is no way to differentiate. (Saying “our people is our differentiator”, for example, is a non-starter. Customers know that good people are table stakes, and everyone has them.) The cost of acquiring new customers in a specific niche will be higher, but so also will be the revenue opportunity. By definition niche is not commodity, but the value delivered must justify the non-commodity price. How will you deliver greater value, and more importantly, a great experience? In the struggle to differentiate, referral business is more critical than ever, so you can’t mail this one in.

Consolidation

There was much talk about exit strategies, as industry consolidation is now in full swing. The sessions on this topic were literally standing room only. In my own presentations, I’ve often predicted and compared this coming consolidation to that which took place in the power generation industry in the early 20th century. It’s happening now. Cheval Capital was again on hand, along with some other M&A advisors, to present the numbers. Valuations, broadly speaking, appear to be running at 10-12x EBIDTA, assuming ownership has properly positioned their business.

Given the M&A mood in the air, consumers of hosting services should build and operate their hosted infrastructure under the assumption that their provider will be acquired. Why? Because when that happens, there is a very good chance you will have to move your infrastructure either to the acquiring company, or to another provider of your choosing if you decide to leave. The buying company is typically buying you, the customer, not the seller’s infrastructure, and it’s likely they will have to move you to make the economics of their deal work. The upshot is that in addition to a disaster recovery plan, you should also consider having a “change providers” plan that details how you are going to move your hosted infrastructure, literally perhaps, in a moment’s notice.

For hosters who want to sell, or have to, a lot of work may be required to position yourself for a good valuation, and it will likely be a multi-year process to get there. Goals and focus are paramount. I’ll share those criteria in a future post.

Growth: Build or Buy?

I’ve often talked about “build or buy” in the context of creating a new product offering. At HostingCon, the context was in regard to whether to grow a hosting business organically or through acquisition.

The general feeling at the conference was that the need to focus on niches will drive an increase in the cost to acquire new customers. In the days of $10/month web sites, the cost to acquire a new customer was $120, or 10x the monthly revenue on average. Moreover, the days of PPC SEO-based methods as a way to get the job done are over – it has simply become too expensive. At some point the cost of acquisition rises so much as to make it worthwhile considering “purchasing” new customers through M&A rather than growing them organically through direct or indirect sales.

For consumers, this means consolidation is ever more likely. Even RackSpace is rumored to be a target.

For hosters, you may have not been considering exiting the business, but if you have a nice portfolio of the right kinds of customers, and your business is in good order, your valuation could now be much greater than you might have imagined.

In Sum

The hosting industry is clearly maturing. You could feel it in the air at the conference. Attendees from small to mid-sized hosters are feeling the pressure to scale big or pick a niche. They see the consolidation handwriting on the wall, and it seemed to be accepted without question for those with $5M-$10M businesses.

There is still great opportunity, but it will require extreme focus, enhanced professional direct sales approaches, and patience. For consumers, this likely means a period of turbulence as consolidation continues. But it also means a new season of opportunity to improve the level of service you receive.

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