May 1, 2002

Subject: Planning ASP Relationships

As systems and software get more complicated and tough to maintain, many companies are outsourcing some or all of their information technology infrastructure. IT outsourcing has become a possibility for even small and mid-size businesses.

Application service providers (ASPs) take over installing, maintaining and providing some or all software applications. This eliminates the need to spend large dollars on hardware, software and support personnel. The ASP model lets you buy access to software and hardware instead of traditional licensing and purchasing. Access is usually provided remotely over the Internet.

A strong case can be made using ASPs. You have to be careful because a lot is at stake when you let a third party handle your business processes and information.

As with any outside vendor agreement, you have to account for the possibility of nonperformance. The ASP may go out of business or may lose the license to some applications. The service may be unacceptable because the ASP has poor servers, Internet connections or both. The ASP may not be able to provide the right level of technical support and help desk services. Upgrades and updates could be badly implemented, causing service disruptions or lost data. Any of these could create serious problems for your business.

THE SERVICE AGREEMENT

Careful attention to the details of the ASP service agreement can reduce the threat of an ASP relationship gone bad. Any service agreement should be clear on the specific required services, pricing, available support and the performance standards. The agreement should also specifically spell out the consequences of failure for each.

If something happens, the parties should know exactly what the remedies will be. Several remedies are usually found in these agreements, like the right to fee credits or liquidated damages, additional services or to terminate the relationship. ASP nonperformance most often leads to termination, so the consequences must be clear in the agreement.

From your perspective, the most important remedy is the right to fire the ASP with little or no notice, depending on how serious the problem. The ASP usually has a fixed number of days to fix problems before termination is effective. You should plan for the problems that may result from having to terminate an ASP relationship and either hire another ASP or bring the IT function back. The relationship with the terminated ASP will not be good. This means that transition services, including data downloads and conversion, may be impossible to get without a specific requirement in the agreement.

Some or all of the applications you use may not be available from other ASPs or vendors. This happens when the ASP is the developer of the software you use. Assuming the applications are available from another source, expect downtime in transitioning to a new provider. This can be a big problem if you depend on one or more mission critical applications for internal operations or serving customers. You will also need to deal with the fact that the terminated ASP may have one or more copies of your data after termination.

It is good practice to include a provision requiring the ASP to cooperate with you, its replacement ASP and other third parties to make the transition as efficient as possible. Some agreements also require a refund and some form of liquidated damages if you are forced to terminate the agreement for cause.

From the ASP's perspective, the most important remedy is the right to suspend or terminate service for nonpayment. Some ASP clients retain ASPs to solve cashflow problems. This makes timely payment for services very important to the ASP. ASP agreements allow service to be suspended on very short notice for nonpayment. You should look out for such a provision in negotiating a service agreement.

CONVERSION RIGHT

One remedy not commonly offered but more frequently requested by users, is a conversion right. This permits you, when an associated trigger happens, to convert the ASP license to an end-user license. Exercising a conversion right may bring the application in-house or use a third party to host the application for you.

For this to be built into the service agreement, the ASP must be an authorized reseller of the software products it provides to you. The reseller agreement must permit the ASP to license the products to users as a paid-up licensee in addition to as an ASP subscriber. If the ASP does not have such a reseller agreement, a fall-back is to require the ASP to try to get this for you at the time of the trigger. This may be possible through the ASPs existing relationship with the software vendor(s). Most ASPs will resist this, especially if the deal is small or not critically important to the ASP.

A conversion right may be helpful if you are not receiving good service from the ASP. It does come with problems. Although you may be able to use software as a direct licensee, you may have to give up any integration related developments created by the ASP. Also, once the use is converted to a standard end-user license, you are responsible for maintaining the product on your servers unless you can get suitable hosting and maintenance services from someone else.

Another issue is the cost to convert the license—an expense you tried to avoid by hiring the ASP in the first place. Finally, it is possible that an ASP in good standing with a software vendor when you sign the contract may not be in good standing when you try to convert or may be unable or unwilling to fulfill its commitment to get a paid license to the product for you.

There are ways to deal with the cost connected to exercising a conversion right. The agreement may allow you to credit some part of the monthly subscription fee toward the end-user license. You might pay an amount above the standard monthly subscription fee to get the right to convert without paying extra at the time of conversion. ASPs may want the conversion right to be exercisable only after a specified number of months of service.

DATA PROTECTION

The agreement should protect and guarantee access to your data. There should be a method of and schedule for, backing up data. Remote backup media storage should be included in the plan. You should require that you be designated as one of the data custodians. The data should be in a standard format or be easily convertible to such a format. This will allow the data to be used by other applications and other environments should you need to use one or more new applications or switch to another ASP.

Data ownership should be addressed. You should require that you own all data submitted to the ASP and any data generated by use of the applications by your employees and agents. You should also own any data produced or generated by the ASP specifically for you under the service agreement. If the ASP will create any specific integration applications or interfaces for you, you should try to get a license for continued use of these even if the relationship terminates.

It is even better for you to get ownership of custom developments. The ASP may require you to give a license to those developments back to it for use for other clients. In that event, you should require that the developments not be provided to a competitor.

You should provide for remedies for intellectual property infringement claims. At minimum, you should be indemnified for any claim by a third party that a product provided by an ASP infringes that third party's rights.

Any of your confidential company information, specifications and customer information must remain confidential after termination, regardless of why or how the termination happens.