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                                                                                    LD
                                                                                    Learning on Demand




Evolving Business Models
in eLearning
Volume 1
Report Overview
Section 1: Rise of the Hosted-Services Model


Tom Barron


December 2001




                                       © 2001 by SRI Consulting Business Intelligence. All rights reserved.
                                            CONTENTS

REPORT OVERVIEW: DEVELOPMENTS SHAPING NEW BUSINESS MODELS... 1
Section 1: Rise of the Hosted-Services Model ........................................................... 1
Section 2: The Growing Role of Vendor Alliances ..................................................... 2
Section 3: Technology Advances Shaping New Business Models ............................ 3
Section 4: New Competitors ....................................................................................... 4
Section 5: Demand-Side Drivers ................................................................................ 5
Section 6: Market Strategies ...................................................................................... 6

SECTION 1: RISE OF THE HOSTED-SERVICES MODEL ....................................... 7
Benefits to Buyers ...................................................................................................... 8
Barriers to Hosting ....................................................................................................   11
   Security Concerns ..............................................................................................        12
   Privacy Issues ....................................................................................................     12
   Limitations on Customization and Integration .....................................................                      12
   IT Departments’ Resistance to Hosting ..............................................................                    13
Recent Developments .............................................................................................. 14
Technology Issues ................................................................................................... 15
Examples of Hosted Offerings ..................................................................................            16
   Pure-Play Providers ............................................................................................        17
   Combination Providers .......................................................................................           17
   Third-Party Providers ..........................................................................................        18
Prospects for the Hosting Model .............................................................................. 19

                                               Figures
Debut of Hosted-eLearning Offerings ......................................................................... 7
Landscape of eLearning-Technology Developers .................................................... 10

                                                Boxes
Benefits of Hosting for Buyers .................................................................................... 9
The eLearning ToolBox ............................................................................................ 11




                                                     i
REPORT OVERVIEW: DEVELOPMENTS SHAPING NEW BUSINESS
MODELS
          Corporate eLearning is in the midst of rapid change. Once an emerging market with
          bright potential, the corporate-eLearning market is growing up to become an established
          industry with a positive early track record. In the past year, an array of eLearning
          technologies have coalesced into defined categories, which have enjoyed various degrees
          of market success. Moreover, the corporate-eLearning industry, once a cottage industry
          of mostly small technology start-ups, is increasingly attractive to larger technology
          players and professional-service firms. In turn, an assortment of compelling case studies
          in recent months have begun to provide evidence of eLearning’s benefits to business, not
          only in offering lower-cost employee training than is possible using traditional means but
          also in enhancing companies’ intellectual capital and competitive edge.
               The Learning-on-Demand (LoD) Program of SRI Consulting Business Intelligence
          has been tracking these developments with an eye to helping eLearning providers and
          adopters adjust to the new realities of the maturing corporate eLearning market. LoD
          analysts have zeroed in on six areas that are relevant to companies seeking successful
          business models in eLearning. These areas explore the broad developments that will
          affect the strategies of existing eLearning providers and new market entrants, including
          technology-based developments, such as the advancing capabilities of Web hosting and
          the move toward object-based eLearning content; business developments, including the
          growth of vendor alliances and partnerships with established technology and consulting
          firms; demand-side factors that are influencing the evolution of eLearning; and market
          strategies that are finding firm footing in today’s soft market.
               Following is a brief overview of areas that each of the six sections of the report
          covers. The remainder of this report begins the in-depth discussion of these six areas by
          exploring the first section: the rise of the hosted-services model.

Section 1: Rise of the Hosted-Services Model
          Hosted-eLearning services have grown dramatically in the past 18 months. Providers of
          purely hosted-eLearning services have entered the fray, many existing providers have
          expanded into hosting services to augment their licensing model, and outside technology
          firms have migrated into the eLearning arena by integrating and hosting eLearning
          applications that they license from providers.
              The hosted-services model is gaining significant traction among buyers—not only
          among midsize and smaller businesses that lack the internal information-technology (IT)
          resources to manage eLearning architectures but also among large corporations and
          government agencies. These buyers recognize several distinct advantages of hosting—
          advantages over behind-the-firewall implementations. Chief among these benefits is the
          growing ability to “preintegrate” eLearning capabilities from various eLearning
          vendors—including learning-management systems (LMSs), content, and synchronous
          tools—to offer a more comprehensive eLearning solution to buyers. With these packaged
          offerings, which companies create through vendor partnerships and licensing




                                              1
          arrangements with third-party application service providers (ASPs), buyers eliminate the
          need to integrate these capabilities themselves and to maintain the integration throughout
          many upgrades of individual components.
              The hosted model faces obstacles such as concern about the security risk of placing
          confidential employee data and other information outside the company firewall. In the
          European Union (EU), regulations that aim to protect individual privacy on the Internet
          complicate the ability of hosted-service providers to service multinational clients. And
          the most robust customization and integration of eLearning with enterprise systems still
          favor behind-the-firewall implementations.
              However, these obstacles are beginning to wane as hosted architectures improve and
          as more middleware applications emerge that improve users’ ability to integrate data in
          eLearning and enterprise applications. The lack of significant security breaches among
          hosted-eLearning providers is also raising confidence in the model.
              This report discusses these and other developments in hosted services. It also
          identifies categories of hosted-service providers and describes large-scale hosted
          implementations that are redefining the potential for the business model.

Section 2: The Growing Role of Vendor Alliances
          The highly fragmented eLearning market, coupled with demand for multiple capabilities
          or a comprehensive eLearning platform and a lack of underlying technology standards,
          has yielded a complex web of elearning-vendor alliances. Many such alliances seek to
          forge interoperability of two or more vendors’ technologies and to assure buyers that they
          will enjoy interoperability among the eLearning technologies they consider. Vendor
          alliances also provide new sales channels and sales strategies for alliance members,
          including joint marketing efforts, referral arrangements, and royalty arrangements. The
          challenge for eLearning providers is to leverage alliances and partnerships effectively.
               In the past 18 months, three categories of eLearning providers—vendors of learning-
          management platforms, off-the-shelf content, and synchronous elearning tools—have
          found good reason to align with their counterparts. LMS providers are the hubs of many
          of these alliances, forming coalitions of content vendors and one or more synchronous-
          tool vendors, which pledge interoperability with their partners’ LMS platforms. The
          content-partner networks that many of the larger LMS makers have created offer valuable
          marketing opportunities for smaller content developers, enhancing their visibility and
          opening a broad new sales channel. They also allow LMS providers to broaden the scope
          of the solutions they offer to customers who are concerned about interoperability.
          Because of the mutual benefits that network partners enjoy, many content-partners
          relationships involve no financial component such as fees or royalties; often, they
          comprise little more than technical integration and marketing coordination. These
          networks are by no means exclusive: Some of the larger content developers have forged
          alliances with multiple LMS vendors.




                                              2
              More complex LMS–content-vendor relationships are in hosted eLearning platform
         offerings that include preintegrated content. In these services, buyers select from the
         content offerings within an LMS vendor’s hosted content-partner network. Buyers pay a
         licensing fee to the content vendor, and the LMS maker (which bears the costs of hosting
         the system) collects royalties from content vendors depending on the volume of content
         that buyers’ license. These arrangements are beginning to generate significant revenue for
         both content vendors and LMS providers, thanks to eLearning adopters’ growing
         embrace of hosted services.
              So-called eLearning ecosystems are emerging as a new form of multiple-vendor
         alliance. These alliances knit together eLearning-technology providers, system
         integrators, strategic consulting services, and network-infrastructure providers. Cisco has
         pioneered this model, which builds on the company’s own integration of multiple vendor
         technologies over its broadband-networking hardware. The ecosystem provides broader
         assurance of interoperability than other alliances do by including broadband hardware in
         the mix; it also adds Internet protocol video capability to the solution.
              Equally significant is the rapid growth of alliances between eLearning-platform
         providers and large technology and consulting firms. These technology and consulting
         firms, which provide services ranging from integration of eLearning technologies to
         strategic consulting on eLearning initiatives and hosting of eLearning platforms, have
         become key partners for LMS makers. They represent vast new sales channels both in the
         United States and abroad. As a result, alliances with these firms are highly coveted and
         critical to leveraging international markets.

Section 3: Technology Advances Shaping New Business Models
         The core technological advance with promise to revolutionize eLearning is the ability to
         author, manage, and deliver learning in the form of “learning objects.” The shift away
         from the course paradigm to modular learning objects moves the field significantly closer
         to delivering personalized learning on demand and reusing learning in different contexts
         for the benefit of different types of learners (see LoD Bulletin, First Quarter 2001).
              Development of learning-object approaches has yielded a new category of eLearning
         technology, the learning-content-management system (LCMS), which helps users author
         and manage content in an object format. Makers of LCMSs have sought to penetrate the
         market either with stand-alone offerings or with systems that are part of larger LMS
         implementations. Large LMS vendors have begun adding LCMS capabilities by
         acquiring LCMS technology or developing it in-house, and they will continue doing so as
         learning-object methodologies mature. In another significant development, companies are
         pairing LCMS and synchronous eLearning technologies to create powerful authoring
         environments for learning.
              Full scalability of the learning-object approach is contingent upon development of
         industrywide standards that allow objects to interoperate over a multitude of eLearning
         platforms, thus removing barriers to broad use and reuse of content. A U.S. government–
         led initiative—the Advanced Distributed Learning initiative—is making headway on that
         front with development of its sharable content object reference model, which provides the
         framework for interoperability.




                                             3
               Unclear, however, is how off-the-shelf content makers will adapt to the new
          paradigm. One content vendor—NETg—helped pioneer the learning-object approach and
          is in a good position to expand on that orientation with its IT and business-skills content.
          Other companies such as SmartForce and KnowledgeNet have also embraced the
          concept, though the two firms interpret the term learning object differently. Other content
          developers or combination content/platform vendors will need to reconfigure their
          technologies to tap into the coming wave of learning-object–based eLearning.
               Demand for more engaging content is also spurring the market for simulation and
          game-based eLearning (see the LoD report Games and Simulations in eLearning).
          Increasingly sophisticated template-based tools for authoring simulations are lowering
          the cost barriers to creating this type of content. Simulation and game-based eLearning
          will likely carve a lasting niche in skills-based learning areas; however, in simulation
          technologies, the need to customize and the inability to modularize such content will
          relegate it to smaller, less scalable markets.
               LoD program analysts have evaluated the impact of these technologies on eLearning
          and identified the new business models they may spawn. They are also exploring
          prospects for the peer-to-peer and other collaborative technologies that are beginning to
          find a role in eLearning environments.

Section 4: New Competitors
          The fast growth of the eLearning market in the past two years and, more recently, the
          steady performance of the market amid the economic downturn have begun drawing new
          competitors from several quarters. These players are migrating into eLearning from
          distinct areas:
          • Professional-service firms. Professional-service firms, including the Big 5
            management-consulting firms, are increasingly helping corporations develop eLearning
            programs and integrate technologies. Their expertise—which comes from their internal
            use of enterprise eLearning—and their global client bases make these firms particularly
            influential players in the eLearning landscape. Two of the Big 5 have already spun off
            eLearning companies, and more spin-offs may follow.
          • Enterprise-software firms. Three large enterprise-resource-planning (ERP) software
            firms—Oracle, PeopleSoft, and SAP—are testing the eLearning waters. Speculation is
            rampant about the potential for ERP firms to move into eLearning-infrastructure
            development as adoption of the technology reaches the mainstream.
          • Universities. With strong brands and a wealth of content, large universities are
            potentially significant competitors in the corporate-eLearning market. Whether they
            can keep up with the technological advances of commercial firms is another matter.
            Some eLearning developers are forging partnership with universities to leverage their
            content and brand.




                                               4
          • Vertical-market specialists. Vertical markets are seeing the growth of eLearning
            providers that cater to their specialized needs. In the IT arena, Web portal DevX is
            creating customized learning sites as well as a public eLearning site to tap demand for
            IT education. Trade associations are launching their own eLearning initiatives in
            partnership with industry-specific content providers and eLearning-infrastructure
            providers.
          • Developers of Web-content-management systems. Makers of general Web-content-
            management software to manage e-commerce (electronic-commerce) Web sites are
            increasingly interested in the eLearning space. These firms, many of them weakening
            as the downturn drastically slows e-commerce Web-site development, may seek to
            segue into eLearning through refinements in their software.



Section 5: Demand-Side Drivers
          The eLearning field has seen a flowering of technology innovations that have inundated
          training managers with choices. Indeed, some critics argue that an excessive focus on
          technology has clouded understanding of what eLearning strategies work best in
          organizations. In this topic area, LoD program analysts examine eLearning from the
          perspective of the buyer and mine the growing number of survey-based and anecdotal
          accounts of the effectiveness of various eLearning approaches.
               Many studies have found that supporting eLearning with instructor-led and
          collaborative activities reinforces learning and helps connect the learning effort to an
          organization’s goals. Use of synchronous learning tools or classroom sessions also helps
          counter the isolation that eLearners experience. Technologies that foster collaborative
          learning fit well with these findings about the value of so-called blended learning
          approaches. As the LoD report eLearning and Culture points out, an organization’s
          unique cultural attributes also affect its ability to harness the medium effectively.
               eLearning adopters must secure support and resources from their IT functions, which
          affects their ability to pursue eLearning initiatives and determines the type of solution
          they settle on. eLearning providers that can help buyers mesh IT and eLearning initiatives
          are most likely to succeed in the market.
               Adopters of eLearning are increasingly sensitive to the quality of content because of
          growing evidence that many learners fail to complete nonmandatory eLearning courses.
          A recent resurgence of interest in instructional-design methodology—rather than
          multimedia bells and whistles—reflects this recognition. Growth of third-party
          courseware-evaluation programs, including a recent American Society for Training and
          Development initiative to establish a program for certifying courseware quality, is
          evidence that content developers will increasingly need to focus on solid instructional
          design.




                                              5
Section 6: Market Strategies
          Drawing on analysis of the first five LoD sections, the final section focuses on strategies
          that eLearning providers can adopt to tap various markets:
          • Strategies that target the horizontal business community. Companies that want to serve
            horizontal business markets will need to demonstrate the enterprisewide impact and
            bottom-line benefits of eLearning, offer a comprehensive solution or means of
            achieving one, provide scalability, resolve pricing issues, and minimize time to
            implementation.
          • Strategies that target specific learner populations. Line functions within
            organizations—such as sales, customer-service, and IT functions—are vanguard
            adopters of eLearning. eLearning providers can specialize to meet the needs of these
            audiences but must be able to demonstrate the value of targeted eLearning initiatives.
          • Prospects for value-chain and customer-targeted eLearning business models. Concepts
            that target value-chain players and customers have generated great interest but have
            seen slow growth in the recent economic downturn. Will such approaches flower as
            eLearning technology evolves and Internet use grows?
          • Strategies that target vertical industries with eLearning offerings. Strategies for
            tapping into vertical markets call for developing custom offerings that appeal to
            specific industries, partnering with relevant organizations, and developing the needed
            sales channels.




                                               6
SECTION 1: RISE OF THE HOSTED-SERVICES MODEL
                Hosting of eLearning software by vendors or third-party service firms is becoming a
                significant business model for eLearning providers. Hosted offerings have grown broadly
                in the past 18 months, and today most vendors of eLearning technology offer hosting
                services, either directly or through third-party application service providers. Growth of
                the hosting model has taken several forms: the launch of providers that offer purely
                hosted eLearning services, existing providers’ expansion into hosting services to augment
                their licensing models, and the migration of outside technology firms into the eLearning
                arena through integration and hosting of eLearning applications that they license from
                providers (see Figure 1).




                                            Figure 1
                              DEBUT OF HOSTED-eLEARNING OFFERINGS*




                                                      EDS
   Application
                                                  General Physics
    Services
                                                    Raytheon




                                                          Saba
    Licensed
                                                      SmartForce
        or                                                                        ThinQ
                                                         Docent
     Hosted                                                                        Sun
                                                      Click2Learn
    Offerings
                                                       Pathlore




                                                  KnowledgePlanet
     Purely
                          VCampus                   GeoLearning
     Hosted
                         DigitalThink                 Oracle
    Offerings
                                                      Isopia



                            1999                          2000                     2001


   * By providers of learning-management platforms.

   Source: SRI Consulting Business Intelligence (SRIC-BI)




                                                      7
              Hosted services go by a variety of names, including ASP services, Web services, and
          hosted services. All these services use an outside provider to house and maintain software
          for a client, which accesses the software over the Web. Increasingly, vendors offer a
          hosting option to clients that want an alternative to the traditional task of licensing,
          integrating, and maintaining the software behind their firewalls. Part of a broader
          technology development that capitalizes on the Web and Web-based software
          architectures, hosting has particular appeal in the eLearning arena for several reasons that
          appear below.
              Many eLearning providers have rolled out hosted versions of their platforms, content,
          or development tools to meet growing demand from prospective clients. At the same
          time, third-party ASP firms that provide hosting services have broadened the channel of
          hosting providers and allowed new competitors into the field. Technology firms such as
          EDS, General Physics (GP), and Raytheon have entered the field through partnerships or
          licensing arrangements with eLearning developers. Other firms such as Oracle and Sun
          Microsystems have entered the eLearning market using hosted platforms. In December
          2000, Oracle launched a hosted-eLearning service that builds on the company’s internally
          developed electronic-business (e-business) software; Sun, which began incorporating
          eLearning into its Sun Education IT-training division in 2000, acquired LMS developer
          Isopia in June 2001 and recently launched an LMS offering that centers on hosted
          services.
              The most sophisticated hosted-service providers are “preintegrating” software from
          multiple eLearning vendors—such as content offerings, synchronous tools, and learning-
          management systems—to provide a robust eLearning platform. A growing percentage of
          eLearning companies operate strictly or predominantly as hosted-service providers, using
          new Web-based software architectures that provide a competitive advantage over
          companies that still market software they designed for client-server–based systems.

Benefits to Buyers
          Whether from eLearning vendors or third-party providers, hosted services provide several
          compelling advantages over customers’ internal implementations of eLearning software
          (see the box on page 9). These benefits, which pure-play hosted-eLearning providers and
          third-party ASPs articulate vigorously, are increasingly attracting the attention of training
          professionals and line managers. The business model has seen a surge of interest during
          the recent economic downturn because it offers an alternative to capital investment, and
          several large platform providers report rapid growth of hosted customers in recent
          quarters. However, the still-novel hosting model continues to invite skepticism from IT
          executives in corporations.




                                               8
                        BENEFITS OF HOSTING FOR BUYERS

• Faster launch of eLearning initiatives than is possible in behind-the-firewall eLearning implementations

• Lower up-front implementation costs for customers

• The ability to leapfrog over an overburdened or resistant information-technology division

• The ability to provide line departments with eLearning resources to meet specific “initiative learning” needs
  (such as new-product rollouts and customer-service training)

• Web-based access to eLearning for geographically dispersed learner populations (such as national retailers or
  multinationals)

• Vendors’ ability to update their technologies without creating additional implementation tasks for customers

• Avoidance of the need to invest in technology that faces obsolescence

• The ability to provide multiple eLearning technologies in an integrated package




               Evidence that eLearning buyers are warming to the notion of hosting appeared in a
          Brandonhall.com poll of customer preferences for LMSs. The poll found that more than
          half (52%) of respondents who had not yet selected an LMS preferred a hosted service to
          an internal implementation. Anecdotal accounts from vendors bolster this finding. Sun
          Microsystems, which provides IT eLearning through its Sun Education arm, reports a
          growing preference for hosting in requests for proposal (RFPs) from prospective clients,
          amounting to roughly 50% of its RFPs. Docent reported a significant uptick in the
          number of customers choosing its hosted solution in its recent quarterly earnings reports.
          Saba Software and ThinQ Learning Solutions report similar growth in demand for hosted
          services; both companies have recently begun emphasizing hosted versions of their
          platforms.
               The eLearning arena has several distinct categories of providers, numerous
          competing “point solutions,” few comprehensive solutions, and a lack of robust
          technology standards to allow for interoperability (see Figure 2). Thus, eLearning buyers
          continually face the need to integrate—to perform custom coding to accommodate the
          application program interfaces of various eLearning software products—as they build out
          initial purchases of content and LMSs to encompass other eLearning technologies such as
          synchronous tools and LCMSs. A U.S. government effort to foster interoperability of
          eLearning products has focused thus far on standards that allow eLearning content to
          operate over multiple LMSs, and the initiative is beginning to yield benefits for
          eLearning adopters. Alliances between content vendors and LMS makers are also
          yielding “plug-and-play” operation of content over LMSs. However, the larger challenge
          of integrating LMSs, content-management technologies, synchronous tools, and
          collaboration software into a cohesive eLearning platform remains for eLearning




                                                      9
           adopters, as does the need to integrate eLearning platforms with larger enterprise-
           software applications. Moreover, integration isn’t a one-time effort; periodic upgrades in
           the components of an integrated platform require ongoing tweaking of the custom code
           that connects applications.




                                      Figure 2
                   LANDSCAPE OF eLEARNING-TECHNOLOGY DEVELOPERS




            Delivery/                Developers of Learning-Management Systems
           Management



           Collaboration          Collaboration-Platform/-Tool
                                          Developers

Learning
                                                Aggregators

 Mode

                              Vendors of                                          Authoring-     Developers
            Self-Paced                                         Custom-                               of
                              Off-the-Shelf                                          Tool
             Learning                                          Content                            Learning-
                                Content                                            Makers
                                                              Developers                          Content-
                                                                                                 Management
                                                                                                  Systems

              Virtual
            Classroom                         Synchronous-Tool Developers


           Performance
             Support/
            Knowledge
           Management
                              Off-the-Shelf                       Custom                       Learning
                              Courseware                          Content                      Objects

                                                               Learning Content

Source: SRIC-BI




                                                10
              The integration challenge, which will continue to frustrate eLearning adopters in the
          absence of comprehensive solutions or robust technology standards, is fueling interest in
          externally hosted offerings that provide preintegration of multiple eLearning
          technologies. The box just below lists some of the many components that eLearning
          solutions must integrate to provide comprehensive offerings.




                               THE eLEARNING TOOLBOX

                • Synchronous platforms               • Simulations and games

                • Asynchronous platforms              • Performance support

                • Customized content                  • Integration with work processes

                • Off-the-shelf content               • Prescribed curriculums

                • Collaborative learning              • Learner-centered materials

                • Knowledge management                • Personalized learning portals

                • Virtual classrooms                  • Mentoring

                • Blended learning                    • Resource center

                • Structured Web-based courses        • E-mail

                • Learning objects                    • Chat rooms and discussion boards




              Pure-play hosted-eLearning providers and third-party ASPs such as EDS and General
          Physics are stepping in with preintegrated combinations of eLearning technologies. These
          providers increasingly offer packages of content, LMS, and synchronous eLearning
          capabilities as turnkey hosted services. As vendors update the components of such
          packages, hosting providers can incorporate the new version without disrupting the
          hosted service. Hosting providers are increasingly able to integrate learner data with
          enterprise applications inside the firewall, though the most robust integration of
          eLearning and enterprise applications still favors behind-the-firewall implementations.

Barriers to Hosting
          Though concerns about the hosting model are clearly beginning to wane, hosting faces
          resistance both in the eLearning industry and in the larger IT arena. Skeptics cite three
          major disadvantages to the hosting model: security concerns, privacy issues, and
          customization limitations.




                                                 11
Security Concerns
Placing sensitive information such as employee data and proprietary information on a
hosted provider’s servers outside an organization’s firewall poses security risks. Such
information is inherently more vulnerable to hackers, who may be able to infiltrate the
Web server or intercept data that pass from the server into the company firewall.
Moreover, companies risk compromising their firewalls when they modify them to
accommodate externally hosted servers.
    The security issue has dogged the ASP industry since its inception in the late 1990s
and is one reason that pure-play ASPs have had difficulty penetrating the market.
Skeptics of the hosted model cite security concerns as the model’s chief weakness, and
some organizations are unwilling to consider external hosting as a matter of policy.

Privacy Issues
Related to security, but potentially more troublesome for hosted-eLearning providers, is
the issue of privacy. Individual privacy is increasingly under attack on the Web through a
variety of mechanisms. By casting personal information beyond an organization’s
boundaries—and in some cases, beyond national borders—hosting heightens the risk of
privacy encroachments.
     However risky hosting may be from a security or privacy standpoint, one immediate
obstacle to hosting is the European regulations that aim to protect Web users from
privacy intrusions. The EU’s European Data Protection Directive, which EU members
have adopted to various degrees, requires organizations to obtain permission to collect,
store, and disseminate personal data. Certain EU countries, such as Germany and Italy,
have adopted particularly stringent versions of the regulations. The directive prohibits
dissemination of personal data outside the EU member country in which the citizen
resides, which limits the ability of hosted-service providers from outside the country to
offer services. One U.S. eLearning provider, Saba, discovered this regulatory obstacle
firsthand while developing a hosted service for a German customer. Though providers
can overcome the obstacle by establishing servers in each EU member country in which
they offer services, the requirement hampers the scalability of hosted offerings and
impedes U.S. providers’ ability to leverage hosted offerings overseas.
     Of course, the EU’s data regulation also affects LMS implementations that span
national borders within the EU—whether these implementations are externally hosted or
not. Therefore, privacy regulations of this sort affect other eLearning models as well. But
adopters of the hosted model are likely to find this barrier particularly vexing when they
try to leverage the model effectively in the EU.

Limitations on Customization and Integration
Organizations that want to integrate hosted services with existing eLearning, human-
resource, or enterprise resources currently hit stumbling blocks. An inevitable trade-off
exists between behind-the-firewall implementations and use of externally hosted services.
Organizations that want the highest degree of integration of eLearning and other
enterprise applications—and are willing to pay the costs of such integration—will be
frustrated when they see hosted services’ limited ability to achieve such integration.




                                    12
    Providers’ ability to customize hosted platforms to meet clients’ preferences is also
more limited in hosted offerings than in other models. Because hosted services are
essentially off-the-shelf offerings, providers cannot customize them to meet a client’s
every need in areas such as user-interface or administrative preferences. However,
developers of higher-end hosted platforms offer the ability to configure—as opposed to
customize—platforms to respond to clients’ preferences. By expanding configuration
options, these providers can offer customization abilities without developing custom code
for each client.

IT Departments’ Resistance to Hosting
Many IT departments in large organizations are reluctant to embrace the concept of
outsourced IT services, partly because of their substantial investment in existing
customized software, which they maintain internally. IT departments also fear that use of
outsourced software will diminish their control of IT resources. In general, larger
companies are less likely to opt for hosted services than are smaller ones; smaller firms
with fewer IT resources (and a less powerful IT constituency) are better candidates.
    Both in the eLearning field and in other business-software sectors, resistance to
hosting also comes from dominant software vendors that have built their businesses on
software licensing. Particularly for public vendors that seek to bolster earnings—and for
many eLearning firms that seek to achieve profitability—the lump-sum revenue from
licensing sales is preferable to the incremental revenue that they typically realize over the
term of a hosting contract. Investors’ and analysts’ expectations of significant increases
in quarterly revenues favor licensing sales over hosting contracts. In addition, licensing
contracts often yield additional revenue for platform vendors that provide integration
services and support. Licensing also creates a more durable relationship with customers
than hosting does: Customers of hosted services can switch vendors much more easily
than licensees can. Though all major LMS vendors now provide hosting as an option,
those that offer both licensing and hosting often steer potential customers toward
licensing-based contracts.
    Some LMS vendors sign up hosted customers with the hope that they convert these
customers into licensing. This approach, which Docent cited in a recent discussion with
analysts, leverages the growing interest in hosting during the economic downturn with an
eye to funnel these customers into the company’s preferred revenue model. The company
says it has a “good track record” in persuading hosted customers to shift to more
customized, behind-the-firewall implementations.
    Vendors of LMSs that use older client-server architectures have technical reasons to
prefer licensing over hosting. Many client-server–based systems, including those that
vendors have updated to function with a Web-browser interface, require at least one
individual server computer for each customer, unlike newer Web-based software
architectures that can host multiple clients from the same server. Thus, client-server–
based systems are at a significant disadvantage when they attempt to compete with the
scalability of hosted offerings.
    A final issue that companies must consider in weighing the pros and cons of hosted
offerings is the relative importance of tax benefits. Buyers of licensed software can
depreciate the costs as a capital investment, whereas subscriptions in a hosted service are




                                     13
         not depreciable. Decision makers must weigh the tax benefits of licensing against the
         costs of continuous upgrades—and periodic replacement—as software becomes obsolete,
         as well as the nondepreciable integration costs. Whether, in the end, the tax benefits of
         licensing will translate into true savings is far from clear.

Recent Developments
         The relative merits of hosted services and traditional license-and-implement approaches
         are an issue of hot debate throughout the Internet-technology arena. As the media have
         amply documented, several early ASP entrants succumbed during the recent technology
         downturn as the number of ASP competitors—more than 1000 by some estimates—far
         outstripped demand. High-profile ASPs such as Pandesic LLC and Red Gorilla have
         fallen by the wayside. Projections that the ASP market would be worth more than
         $6 billion by the end of 2001 were well off the mark, and some prominent critics have
         expressed doubts about the future significance of the business model.
              Nonetheless, though early excitement about outsourcing software clearly outpaced
         technology capabilities and successful business models, hosting has gained new
         champions from several quarters as it has matured technologically and as demands on
         corporate IT departments have continued to grow. More technology developers are
         offering hosted versions of their software directly to customers, providing competition to
         third-party ASPs that must license the software. In the e-business arena, Oracle,
         PeopleSoft, and SAP have each unveiled hosted versions of their enterprise software.
         More than 100 customers of Oracle’s ERP and customer-relationship-management
         applications use its hosted service, according to Business Week, doubling the number of
         such customers in the past year. Oracle’s outspoken CEO, Larry Ellison, recently
         challenged the “best-of-breed” integration approach that dominates the business-software
         arena, arguing that such integration raises the costs of enterprise applications to
         unacceptable levels. His comments accompanied Oracle’s announcement that it will
         charge a flat fee for internal implementations of its e-business platform and expand its
         hosted-service offering through a partner network that includes ASPs and content
         providers. This step is part of a general move toward multipartner offerings in the
         eLearning market.
              At the same time, technology giants Microsoft, IBM, Sun, and others are racing to
         establish dominant platforms for developing Web-based applications. Microsoft’s .NET
         initiative and a rival platform from Sun, which target both software developers and
         hosted-service providers, are helping to broaden the concept of software as a service
         offering. Unlike hosted applications, these so-called Web services target not end users but
         software developers. One early example of a Web service is Microsoft Passport, an
         authentication service that other Web sites can use to verify that users are who they say
         they are. eLearning providers may pursue their own Web-services offerings; for example,
         developers of learning-object–based content could publish objects in a service format in
         which a royalty accrues each time other content developers use an object to assemble
         eLearning courses. One start-up firm, Lydia Inc., is pursuing just that approach, though
         whether it will be successful is not yet predictable.




                                             14
              Some observers of the software industry compare the impact of the hosted-software
         model with companies’ migration from the mainframe to client-server architectures and
         then to the Internet. Each shift yielded concerns about data security, the opportunity for
         new entrants to establish themselves, and resistance from the vendors that dominated the
         existing paradigm. In this case, further resistance is coming from powerful IT
         constituencies within organizations, which see the outsourced-software model as a threat
         to their hegemony.
              In areas such as enterprise software, the hosting model must become compelling
         enough to unseat investments that organizations have already made in licensed—and
         often customized—applications. However, in the young eLearning arena, many
         organizations are making their first significant investments in eLearning technology,
         which provides a significant opportunity for hosted-services providers. With no need to
         debate whether to upgrade existing technology, new adopters of eLearning—or
         organizations that have invested in only one or two components of an eLearning suite—
         can approach hosted offerings with greater latitude than in other technology areas.
              Though hosted services typically target midsize and smaller businesses that lack
         extensive IT resources, a growing number of large organizations are opting for hosted-
         eLearning services. Eastman Kodak, a Fortune 150 company with more than 80 000
         employees worldwide, recently chose a hosted solution for its eLearning initiative, citing
         many of the benefits of hosting that the model’s proponents suggest. The company cited
         its desire to move the initiative off the ground quickly, the need to avoid burdening its
         already hard-pressed IT department, and budget constraints that made hosting preferable
         to a large up-front outlay for a licensed offering. Other large organizations that have
         embraced hosted-eLearning services include Dow Corning and General Motors, both of
         which chose hosted services over internal implementations for their sizable eLearning
         initiatives. Lucent Technologies is using a hosted service for an eLearning program that
         targets the firm’s telecommunications customers. And several recent U.S. government
         contracts, including the bulk of a recent U.S. Navy initiative that targets more than
         1 million learners, use hosted services from eLearning providers.
              A recent surge in hosting contracts reported by leading LMS providers indicates that
         the recent economic slowdown is forcing organizations to pursue the hosting option. In
         its second-quarter earnings report to analysts in 2001, Docent said it signed triple the
         number of hosted customers it expected to during the quarter. CEO Dave Ellett attributed
         this jump to budget considerations that are forcing companies to pull back on IT
         spending. Though Docent expects to see a rebound in the proportion of licensing
         contracts it signs—which it favors over hosting revenue as a faster means to
         profitability—the recent growth in hosting may indicate that concerns about security are
         beginning to fade. The downturn appears to be fueling growth of the hosted model.

Technology Issues
         A number of technology issues will help determine whether the hosted model enjoys
         substantial future growth in eLearning and other areas.




                                            15
          • Growth of “middleware” applications improves integration. Though custom
            integration of eLearning and enterprise applications is still easiest in behind-the-
            firewall implementations, the technologies that allow externally hosted applications to
            share data with a customer’s internal enterprise applications are rapidly improving.
            More robust integration of hosted applications with enterprise applications such as
            enterprise-resource management, customer-relationship management, and supply-chain
            management is becoming possible with advances in Extensible Markup Language
            (XML) and other Web standards. Certain middleware products—a broad term for
            software that resides between the server and the client—seek to accomplish such
            integration, both in internal implementations and in combinations of hosted and internal
            implementations.
          • Preintegration of point solutions provides time and cost advantages. Hosted-service
            providers that can “preintegrate” point solutions have a significant opportunity to
            reduce the time and implementation costs necessary to build eLearning capabilities.
            This custom integration offers a compelling alternative to internal integration of
            eLearning components. Moreover, it reduces ongoing maintenance requirements, such
            as the need to integrate upgrades of individual components behind the firewall.
          • Web architectures minimize security risks. The use of new “n-tier” Web software
            architectures—which allow systems to divide data among multiple servers—allows
            organizations to sequester proprietary or sensitive information on servers inside their
            firewalls. The hosted provider’s servers link to these content servers without passing
            sensitive information over the Internet. This capability, which significantly reduces the
            security risks of external hosting, is available in hosted applications from MindLever
            (now part of Centra) and other hosted-service providers.
          • Web architectures improve the scalability of hosted solutions. N-tier software
            architectures, including Sun’s Enterprise JavaBeans and Microsoft’s SOAP
            architecture, also improve the scalability and customization capability of hosted
            services. These architectures not only allow providers to host multiple clients on a
            single server and to divide presentation, content, and delivery among multiple servers,
            but also their modular nature allows easy modification to suit customer preferences.
            Advanced platforms that developers design with Web software tools feature powerful
            configurability options for administrators and end users that eliminate the need for
            custom coding.



Examples of Hosted Offerings
          Three categories of providers dominate the hosted-services landscape: pure-play
          providers, which build business on the hosting model; combination licensing/hosting
          providers, which include many companies that favor licensing contracts but provide
          hosting services (directly or through a third party) at a customer’s request; and third-party
          technology firms, which license eLearning technologies and offer them to their customers
          in a hosted fashion.




                                              16
Pure-Play Providers
Pure-play hosted-service providers include LMS providers such as KnowledgePlanet and
VCampus, together with Oracle, which launched a hosted LMS service in late 2000 that
draws on its internally developed LMS. Other pure-play companies provide content and
LMS capabilities; DigitalThink and KnowledgeNet are leaders in this area. Numerous
niche content providers offer their ready-made content with some learning-management
capabilities or other features that are possible with hosted delivery.
     KnowledgePlanet has been one of the most forceful advocates of the hosted model;
the company offers an enterprise LMS/competence-management system that analysts
consider state of the art. The company has also amassed a cadre of third-party content
providers, which have adapted their content to function with KnowledgePlanet’s KP2000
LMS. KnowledgePlanet has established itself as the hosted alternative to enterprise-
strength LMSs that companies implement behind their firewalls. Its customer list includes
major industrial, financial, and professional-service firms.
     On the content side of eLearning, LogicBay is an example of a custom-content
eLearning provider that develops hosted “online universities” for customers. Through
alliances with major LMS providers, the company provides its custom content on an
LMS platform in a hosted environment. Recently, it added synchronous eLearning
capabilities to its offering through an alliance with Centra. Its integrated offering
illustrates the ability of hosted providers to create turnkey packages with multiple
capabilities by forging alliances with other vendors.

Combination Providers
Numerous eLearning providers fall under the “combination” category, including firms
that offer hosting as a preferred option, licensing-based providers that offer hosted
services on request or through a third party, and companies that migrate to the hosted
model from other business models. The large number of firms in this category—
including major LMS and LMS-plus-content makers such as Saba, Docent, ThinQ,
Click2Learn, Pathlore, and LearnFrame—illustrates the speed with which vendors are
responding to demand in the market for hosted services and the relative ease with which
they can offer their products in a hosted format. In many cases, licensing-based providers,
in the interest of building market share, have rolled out hosting services rather than turn
away potential customers, even though their technology and business models emphasize
licensing. In other cases, the dual-delivery approach reflects a genuine migration toward
hosting or an effort to balance hosting and licensing delivery models.
     Enterprise-scale learning-management providers such as Saba, Docent, and Pathlore
are among the licensing-based providers seeking to co-opt the hosting movement by
offering hosted services. In fall 2000, Saba launched the Saba Learning Network, a
scaled-down version of its enterprise LMS that it offers as a hosted service; the company
also offers hosting of its industrial-strength Saba Learning Enterprise. The company
began promoting its hosted service in 2001 as organizations began cutting back on IT
expenditures, and in recent months, it announced hosting contracts with the U.S. Customs
Office, the U.S. Federal Law Enforcement Training Center, and the University of
Wisconsin. Docent and Pathlore launched hosted versions of their LMSs in 2000. In all




                                    17
three cases, the hosted option is secondary to these firms’ primary preference for
licensing contracts, as is evident in their positioning of the two options on their Web sites
and in their marketing materials.
    SmartForce is a combination provider of another stripe, one that has embraced the
hosting model as its central offering. The eLearning provider made this shift in fall 2000
with the release of its My SmartForce platform, a hosted service that combines off-the-
shelf content with collaborative, synchronous, and mentoring components. The company
has since strived to migrate its customer base to the hosted platform while continuing to
offer a behind-the-firewall solution. SmartForce recently purchased Canadian LMS
maker icGlobal and has integrated icGlobal’s highly rated icCampus LMS into its
offering. The company also plans to offer the LMS as a stand-alone solution in both
hosted and licensed formats.
    ThinQ Learning Solutions started as a content aggregator that was savvy enough to
move beyond the portal model through its acquisition of LMS developer TrainingServer.
The company has since become competitive with pure-play LMS firms by providing the
broadest range of off-the-shelf content along with its LMS and custom content-
development capabilities. More recently, it has expanded into hosted offerings, and in
recent months, it won two sizable contracts for its hosted services: In addition to working
with Kodak, the company recently launched a hosted-eLearning service for the U.S.
Navy that, upon full implementation, will provide its eLearning to more than 1 million
navy personnel. Through integration of the hosted service with the navy’s internal
enterprise database, the navy will be able to maintain learning transcripts for its
employees.

Third-Party Providers
Perhaps the most dramatic development in corporate eLearning has been the migration of
larger technology and engineering firms into the field through use of the hosting model.
Old-line technology firms such as EDS, General Physics, and Raytheon are expanding
into eLearning and other growing markets as service providers, offering customers
integration services as well as hosted services that often integrate multiple products.
These firms’ established customer bases provide a significant advantage over the limited
sales channels of pure eLearning providers. Their ability to integrate multiple
technologies to provide a more robust eLearning solution is another major benefit for
customers seeking to avoid the costs and delays of integrating point solutions internally.
    General Physics’s eLearning division, GP eLearning Technologies, is among the
outside technology providers that have moved into eLearning via ASP hosting. In recent
years, General Physics has built a sizable training practice targeting technicians and IT
and engineering professionals as a sideline to its engineering work. In 2000, it launched
an eLearning division that comprises integration services for behind-the-firewall
implementations, custom eLearning content development, and hosting services through
agreements with eLearning-technology developers. Through alliances with Saba and
Docent, and later, ThinQ and Centra, GP began offering hosted services to existing
customers in fall 2000 and has begun to seek new business from organizations seeking
the benefits of hosted eLearning.




                                     18
              GP landed a high-profile contract in January 2001 to provide hosting services for
          General Motors University, the automaker’s corporate university that serves its 65 000-
          employee workforce. GP credits its long relationship with General Motors for its win
          over rival bids. The company is providing Saba’s enterprise LMS in a hosted format to
          users of the university. More recently, GP announced a contract with New York
          University to host an integrated service that includes Docent’s LMS, Centra’s
          synchronous platform, and other components.
              Technology services giant EDS has been even more aggressive than GP in its pursuit
          of eLearning business through hosting. In an industry-shaking partnership with
          DigitalThink that the partners announced in July 2000, EDS purchased $50 million in
          services for its employees and promised to deliver $100 million in revenue to the
          eLearning firm from sales of the platform to customers. Under the agreement, EDS
          provides the integration and hosting services. Since then, the company has expanded the
          offerings in its hosted Digital Learning program to include synchronous components
          (through a partnership with Centra) and off-the-shelf content (through alliances with
          various content developers), which it combines with DigitalThink’s LMS.

Prospects for the Hosting Model
          Discussions with vendors and adopters of eLearning, along with observations of market
          developments, suggest the following outlook for the hosting model.
          • Hosted offerings will continue to gain ground on licensing-based contracts. The
            benefits that it provides various classes of organizations, together with growing
            sophistication of its security and technical aspects, will continue to fuel the growth of
            the hosting model in the eLearning arena. Though current estimates peg hosted
            offerings at roughly one-third of the total corporate-eLearning market, I believe
            hosting’s market share will equal or exceed that of licensing by 2003.
          • The current economic downturn will accelerate the growth of hosted offerings. Tighter
            budgets for training and IT functions will force organizations—even those that may
            later migrate to licensed implementations—to pursue hosted offerings. Evidence of this
            development appears in the most recent earnings reports by public LMS providers,
            which cite a distinct rise in hosted contracts as a result of customers’ budget
            constraints.
          • Hosted offerings will increasingly preintegrate multiple components. A key benefit of
            hosted services is their ability to preintegrate components from multiple vendors,
            including LMS capabilities, content, synchronous and collaboration tools, and LCMS
            functions. Leading providers of hosted solutions, including eLearning vendors and
            third-party hosting providers, will increasingly harness this capability.
          • Technology giants’ embrace of hosting will accelerate adoption of the hosted model in
            eLearning. The general move into hosting by enterprise-software providers, and the
            growth of Web services from dominant IT firms, will reduce IT departments’ resistance
            to hosting. However, though the market as a whole will become increasingly receptive
            to hosting as Web technologies advance and security concerns wane, a diminishing
            market segment will continue to resist hosting for “political” reasons.



                                               19
• Hosted services will find an increasingly compelling market in large, distributed
  corporations and in customer-focused implementations. The abilities of hosting
  providers to offer scalable eLearning to employees in multiple locations and to
  maintain around-the-clock availability of eLearning Web sites will be compelling
  draws for large, distributed organizations such as corporate retail franchises. Similarly,
  organizations targeting their customer base with eLearning offerings—such as trade
  associations, Web-based service firms, and Web retailers—will find the infrastructure
  savings and scalability of hosting preferable to their own maintenance of these
  consumer-focused eLearning Web sites.
• Europe will be slower than the United States to embrace hosting. The EU’s European
  Data Protection Directive will hamper the ability of hosted-service providers to scale
  their offerings to serve multiple EU member countries. However, the ability to contain
  sensitive data on servers within a customer’s firewall, through the use of new n-tier
  Web software architectures, will likely overcome this legal hurdle. Equally significant
  is Europe’s general preference for custom-developed content over off-the-shelf
  solutions, which will continue to favor behind-the-firewall implementations of custom
  solutions.
• A widely publicized security breach or ASP gaffe could set back hosting. Because
  hosting is a relatively new business model that must overcome people’s doubts about
  security and related issues, hosted services must maintain an unblemished track record
  in those areas. A high-profile infiltration of a hosted provider’s servers or another gaffe
  that compromises sensitive data—either in the eLearning field or in the larger IT
  arena—could renew security concerns and increase resistance to hosting. Similarly, a
  rise in so-called denial-of-service attacks by Internet hackers could reduce confidence
  in the model.
• Client-server–based systems will require major overhauls to compete with Web-based
  architectures. Some eLearning-platform developers whose software relies on client-
  server architectures have been able to move to the Web through “front-end”
  modifications that allow them to use Web-browser interfaces. However, these older
  architectures are poorly suited for use in hosted services because they require multiple
  servers for each client. They also are unable to sequester customer data on separate
  servers that remain inside the customer’s firewall, as do the newest Web-based
  architectures. As a result, these providers need to update their software if they are to
  compete effectively as hosted-service providers.
• Incremental revenue from hosting will appeal to established, profitable eLearning
  players. Currently, demand from public and private investors for maximum quarterly
  returns forces eLearning vendors to favor lump-sum licensing contracts. As these
  players approach or achieve profitability, the hosting model will become an appealing
  means of ensuring a stable cash flow through regular collection of subscription fees.
  The predictable and steady revenue that hosted services derive from customers will
  allow providers to predict their financial needs and opportunities better than they can
  now. In the long term, providers of hosting services will see far greater revenue from
  each customer than they could realize in a licensing arrangement.




                                     20
• Hosting models will place a premium on quality of service. Providers of hosted services
  will need to focus on service quality to maintain and build their client base. The ease
  with which customers can switch vendors (changing licensing-based contracts is more
  difficult because of capital investments and custom integration) will force vendors to
  focus on quality of service. Vendors will seek to steer buyers of hosted services toward
  multiyear hosting contracts to build and maintain a stable revenue base.




                                   21

				
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