November 1, 2000

What is an ASP?

‘Application Service Providers (ASPs) deliver and manage applications and computer services from remote data centers to multiple users via the internet or a private network.’

– ASP Consortium

An ASP is a business that provides a service, including providing access tosoftware applications. Subscriber customers connect via the Internet or aprivate network rather than loading the software at their own site. The providerhosts the software, and provides the customer with agreed software availabilityin return for a subscription fee.

This allows companies to deploy applications without the associated cost andburden of owning, managing, supporting or upgrading the applications orunderlying infrastructure. ASPs can offer more rapid and comprehensiveimplementation and support plans than the alternative (in-house supply), andpotentially a cheaper exit route. The real cost benefits come from the ASP’sability to take advantage of the economies of scale in relation to hardware,software and IT staff, and to pass some of those savings on to its customers. Italso has the advantageJohn Kilbeyof allowing ASP customers to stay focused on their core business and to off-loador share with the ASP some of the risks and responsibilities of using IT.

Actual use of ASP remains at a low 7% of market share, but given theadvantages recognised by potential users this seems likely to increase in thefuture.* Examples of ASP services:

  • Cable and Wireless have launched their new a-Services
  • Vistorm (formally Esoft) at Vistorm provides line-of-business applications over the Internet or via leased lines to small or medium-sized enterprises.
  • CIX (Compulink Information eXchange) at CIX is an example of an ISP capitalising on its network communications talent and moving into the ASP marketplace.
  • Appcity is aimed at the smaller business. Appcity design and host the application and aim to deliver within one day.

Whilst prospective customers when questioned stated that they preferred anall encompassing ASP supplier unhindered by partnerships*, in all likelihoodmost ASPs will be partnerships, joint ventures or, at a minimum, third-partysoftware. It is asking a lot for one company to be expert and able to providethe telecommunications, hosting, network structure, software, and servicemanagement capability needed to be an ASP provider. Good supplier/partnercontracts and service level agreements are a must prior to any customer servicecontract.

Software as Services

The main difference to bear in mind when constructing an ASP contractcompared to the standard licence model is that what is being sold to thecustomer is a service, not a product/licence. As such, the contract willdescribe the service being provided (rather than listing software), and wouldtypically include the following:

  • An overview of the service at the start of the service description helps any reader of the contract to understand quickly the service being provided.
  • The functionality to be made available – this will be the functionality of the software, detailing the actual functionality that the customer will receive.
  • The technical description of the service may also be included as, for example, may methods of access over a private network.
  • The management procedures details – for example, named service delivery manager, project plan, training, service delivery procedures, data transfer procedures, ongoing management and change control.
  • There must also be full details of the reports to be provided; as a minimum, the frequency, subject matter and level of detail need to be indicated.
  • The service description should detail security provisions for users and data. Customers want reassurance that data held on remote systems is as secure as their own procedures – although this need not be a full specification, a simple page describing security arrangements will suffice for most ASP services. In this area, concern over loss of control may be more sensitive. Knowledge of the level of security needed by that sector serves the ASP well.
  • Finally, you must cover the most contentious area – service levels. This area covers the level of service to be provided, escalation procedures to be used in the event of failures and potential service credits.

Service Levels

Service levels are the core of an ASP contract. Suppliers should rememberthat service levels may suffer from the law of diminishing returns –increasing a particular service level even by as little as 0.5% may not becommercially possible in the short term. Suppliers should realistically assesswhether or not their system is capable of providing the service levels offered,and solicitors should ensure that their clients are well aware of the dangers ofoverestimating their potential in pursuit of the ‘hard-sell’.

Service levels must be crystal clear. It should be obvious on one readingwhat each measured element means. If the elements are not clearly defined, thecustomer is unable to assess whether the service provided will fit itsrequirements, and should the service begin running on this basis, neither thecustomer nor the supplier will be able to assess if the service is performingwithin the agreed parameters. Inadequate provision in this respect can only leadto disgruntled customers and thence to disputes.

Service levels need not address merely whether an element of the system is onor off, but may also quantify system response times and performance. The methodsfor measuring availability should also be clearly documented in the contract.There is as yet no clear industry standard for this, or any industry-recognisedleading software that will do this. Measurement of availability is a contentiousarea, but it is better to be up-front with the customer rather than attemptingto gloss over the issue.

The provision of service credits is on the increase across both ISPs and ASPs.Service credits are a type of liquidated damages – compensation from thesupplier to the customer for substandard service. This is usually subject to acap, for instance 10% of that quarter’s fee. The supplier must thereforeensure that there is a statement within the contract that the customer acceptsthat the service credits are adequate recompense for the drop in service or elserisk paying out twice. The provision of service credits should cover only alimited degree of failure. If an element is stated to be available for 99.9% ofthe time, service credits may only cover availability between 96% and 99.9% orthe supplier runs the risk that the service credits fail to be a ‘genuinepre-estimate of loss’.

An alternative approach is to allow users free access to the system for aperiod of time equal to that for which they were unable to access the systemthrough a fault attributable to the supplier. This has the added benefit thatmoney is not repeatedly changing hands between supplier and customer withattendant administration costs, and potentially will work out cheaper forsuppliers to operate.

If more than one aspect of the service is measured, some thought needs to gointo assessing how these elements will be calculated to give the overall’availability’ figure. Averaging availability across long periods (threemonths is fairly standard) reduces the supplier’s risk since the peaks andtroughs will average out – hopefully to a level above the service levelthreshold!

If there is more than one element of the service to be measured, there are anumber of ways to produce the overall ‘availability’ figure. Taking the meanavailability across all elements may substantially reduce the supplier’s risk,since over-performance on one element will compensate for under-performance onanother. If attainment targets on one or more elements are generally guaranteedto be reached in any circumstances (eg electricity supply reaching the server99% of the time), under this averaging system, these elements tend to ensurethat the supplier rarely pays out service credits. Customers may complain loudlyif they do the maths, and may insist that service credits are measuredseparately, and that service levels are increased on some key elements.

In order for the service levels to be assessed by both sides, the suppliermust keep accurate records of availability. The supplier will be obliged toprovide copies of these service reports in support of the supplier’scalculation of service credits. This could be at least quarterly on request, andmore likely automatically at the end of each quarter. The provision of servicereports is another opportunity to emphasise the supplier’s accomplishments andbranding. The supply of reports automatically, even when things are going well,reinforces a positive image of the supplier in a market where positive brandingis likely to be important among a number of generic providers.

Service Management

Since this is the provision of a service, maintenance of the clientrelationship is an integral part of the service. It not only deserves to betrumpeted as such in the contract, it needs to be. This is important at theinitial set-up stage, but does not diminish during the ongoing relationship. Thecontract should name a Service Delivery Manager responsible for all aspects oftake-on and set-up of the service. The Service Delivery Manager will be the mainpoint of contact during early issues of data transfer and networkingspecifications, but once established will be as heavily involved in maintainingthe required level of service.

Depending on the value of the relationship, the ASP may also considerappointing a named ‘client manager’ to govern the commercial relationshipwith quarterly account meetings. This can be a way to get early warning of badservice over and above failure to achieve service levels – there is as yet nocontract metric that captures ‘friendliness of staff’ levels. The clientmanager is then in a key position to identify if the customer is thinking oflooking elsewhere in the marketplace or, worse, has found a close ASPcompetitor.

The client relationship may also be a public partnership. This can beadvantageous for the customer since it knows that if anything goes wrong thesupplier will be equally visible and embarrassed by the failure, andadvantageous for the supplier since it gets its name linked to high profilecompanies. The contract should govern publicity statements referencing the otherparty, with provision for review of each other’s publicity material beforepublication.

The supplier may want to set up a customer forum where customers can discussthe service and recommend software customisation, additional security orprocedural amendments. This provides a valuable source for considered customerfeedback, limits differentiated customer requests which cannot all beaccommodated (ASPs are more constrained than a provider of in-house software),and enables each customer to feel they have ‘had their say’ in thedecision-making process.


One of the often touted advantages for the customer of the ASP model is thatthere is no large initial set up fee when compared to the capital purchase onin-house supply. This isn’t necessarily so. ASPs may still be charging a’licence fee’ despite there being no licence granted to the customer –remember the customer is receiving a service. There are a number of possibleexplanations. The ASP may have to pay its software suppliers a fee, payable ontake-on of each new ASP customer. This cost would need to be passed through assoon as possible. The ASP may just prefer a lump sum up-front rather thanspreading its cost recovery over time for reasons of cash flow. Alternatively itmay just be habit hanging on from a time when the ASP provided the customer witha licence and maintenance. It is as well to check which explanation applies.

An ASP has capital outlay for each new customer and may consider an’initial set-up fee’ as a way of recovering this cost (this cost is stilllikely to be cheaper than the cost of in-house supply). The set-up cost may beaveraged over the life of the service, but the ASP must be sure that all isrecovered in the event of early termination either by setting a fixed initialperiod or a termination charge.

The pricing of an ASP service will probably be a set subscription fee permonth/quarter. The contract should provide for an initial period calculated inaccordance with the supplier’s return on costs.

The fee is usually all-inclusive of the core service (except VAT), typicallycomprising:

  • software made available for use;
  • helpdesk support;
  • maintenance of supplier system.

Whether the periodic subscription model should include an initial set-up feeis a matter of commercial choice. ASPs who are familiar with the traditionallicensing fees model may be reluctant to lose the early lump sum commonly paidunder that model. The prospect of having to spread profitability over a lengthyperiod, particularly where large set-up costs are faced, may make accounts lookpoor and therefore be unattractive. One consequence of this is the ‘hang-on’of terminology, whereby ‘licence fees’ are still charged by ASPs despitethere being no licence.

There are likely to be optional extras that provide an ‘enhancedservice’. It is necessary to run a few quick checks of the pricing model toensure that the simple monthly fee does not get overly complicated. The clued-uplawyer will also check the impact of these extras on the service creditcalculations. If the customer is paying yearly up-front for the optional extras,any service credit defined as a percentage of that month’s payment will beincreased for that month (and if something is going to go wrong with the servicethe first month is a likely candidate). It is also necessary to check the impacton service credits if these extras are taken on part way through the term.

Alternatively the price may be based on a ‘per use’ basis. The actualmeasurement of ‘per use’ must be carefully defined. If a customer logs on,but leaves the software idle, is this ‘use’? If use is defined on a’concurrent user’ basis, what is the effect of exceeding the agreed numberof users – does the software lock them out or are penalty fees payable for theextra users? What is the effect if further applications are added months intothe service? How does payment per use affect the service credits in thecontract? There is little point having service credits payable as a percentageof ‘per use’ if the fault in question meant that the users could not get onthe system or log their time.

Training and customer site visits will be priced separately from the periodiccharge since these are dependent on variable factors like the number ofdelegates and location of the customer. The supplier should also consider theexpenses to be incurred on these items. These are usually calculable in advanceand the supplier may give a training cost inclusive of expenses.

The supplier should consider the effect of the customer cancelling training.Commonly, provided the customer provides requisite notice (for example, twoweeks), there is no charge, but the customer pays the full fee if it fails togive notice of cancellation after that.

As a rolling contract, all fees should be capable of increase year on year.The customer will request that the initial period is price-fixed and that priceincreases thereafter are capped. If fee increases are capped, the suppliershould carefully consider which cap is appropriate. Various caps are available:

  • a simple % cap (eg no fee to increase by more than 10% per annum);
  • a link to RPI + % ( eg no fee to increase more than the retail price index plus 5%);
  • a link to a technology industry index (eg no fee to increase more than the CEL index).

The CEL index is produced by Computer Economics Limited ( tracks remuneration inflation in the technology industry. This index hashistorically shown that the inflation of IT staff wages greatly outstrips RPIinflation (between 7-10% over the last five years), but it is necessary to be asubscriber (at a cost of from £575 per annum) to access this information.Members are able to query the database online. Even if the supplier is asubscriber and has access to the index, customers may complain that they arenot, and therefore any fee increase is unverifiable by the customer.Transparency in charging is vital to the service-provider relationship.


It bears repeating that an ASP is providing a service not software to thecustomer and as such the agreement with the customer is not a licence.

It is still necessary to ensure that the ASP is allowed to provide this typeof service to its customers under its existing supplier licences. These licencesmay be tightly drawn to specifically exclude the provision of ‘ASP services’or ‘bureau services’.

Sources *data supplied by PMP Research
ASP – The Reality Check CSSA conference, Wednesday 27th September, 2000
ASP consortium
ASP News
Computer Economics Limited
CSSA contract guidelines
Pegler v Wang Unreported, but discussion
available at:

It is also still essential to pin down precisely ‘who is the customer’. Ifyou have priced to provide the service to a small 50 employee company, you donot want to find you have accidentally provided the service to the entire groupconsisting of 50,000 employees.

Limitation of Liability

It is usual for this clause to be the last to be agreed in any contractnegotiations. Liability for failure to meet the service levels within the scalesagreed will be covered by the service credits. Liability for failure over andabove these levels will be limited by the limitation clause. Clearly manycustomers will regard their IT as a business-critical service, so the questionsover consequential loss will certainly need to be addressed with ASP clients.With the courts taking a hard line on the viability of excluding consequentialloss following the decision of the court in Pegler Limited v Wang (UK) Limited(see vol 11, issue 1, p 29), it is advisable to consider abandoning any attemptat limiting consequential loss in favour of providing realistic overall limitsof liability backed by comprehensive insurance.

Term and Termination

The term of the contract is likely to be defined by reference to an initialperiod plus annual rollover until either party terminates by giving therequisite notice.

Ease of exit is one of the selling points of an ASP contract compared toin-house supply. The supplier should bear this in mind when calculating initialperiods/minimum term, notice periods and termination charges in order that thisadvantage is not unnecessarily eroded. Clearly the supplier’s own contractualresponsibilities and reliances as regards third parties should be very carefullyconsidered.

Termination of the service by the supplier may cause considerable disruptionto the customer if the service is core to their business. The notice periodshould provide sufficient time for the customer to migrate to an alternateservice. In practice a period of between three and six months is likely. Thesupplier should also offer to use all reasonable endeavours to aid the migrationof the service.

If the ‘notice for convenience’ clause is reciprocal, suppliers may seekto justify lengthy notice periods by pointing to the potential disruption forthe client in the event of termination by the supplier. Since termination forconvenience is most likely to be triggered by the customer, and in any event thecontract can always be drafted to provide for different notice periods for thesupplier and customer, this argument would not appear to stand close scrutiny.


Many new ASPs moving into this market will be more familiar with thetraditional licensing model. This traditional model has the strong attraction oflinguistic and accounting familiarity that some ASPs may find hard to shake off(watch for ASPs charging a ‘licence fee’) which will exert an influence overcontract drafting. It is vital that ASPs are able to move away from such cosycomfort, and see Application Service Provision as a market that has more incommon with outsourcing, Business Process Management, AM or FM services –where management of the service is key. It’stime to call a service a service – the contract certainly should.

Hazel Raw and John Kilbey are Trainee Solicitors at v-lex limited.