Oracle Edging Closer To The Hosted Model

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As more big software firms target the midsize business market, tiny NetSuite Inc. stands out in a number of ways.

For one, Oracle Corp. Chief Executive Larry Ellison co-founded and owns the biggest chunk of the privately held company.

For another, NetSuite might be the only company to provide hosted software that's geared to help medium-sized companies run both their back- and front-office operations.

Other "software-as-a-service" providers concentrate on the back or front office, since those operations differ so much.

Front office refers to a company's operations that deal with customers directly, such as marketing and customer service. Back office refers to internal departments, such as personnel and accounting.

The big software companies are starting to offer the hosted approach. The ties between Ellison and NetSuite - Ellison is a director - offer intriguing possibilities for Oracle's future, observers say.

Ellison Keeping Arm's Length

"NetSuite is its own company," said Sheryl Kingstone, an analyst with the research firm Yankee Group. "Larry Ellison, of course, has some say. But he's not too heavy-handed because he has so much else to work on."

Ellison co-founded NetSuite, then called NetLedger, in 1998, in part to gain a foothold in the emerging hosted model.

Hosted software is maintained by the provider, such as NetSuite. Customers connect to the software via computer networks as needed, and they pay as they go. This model requires no big upfront purchase or license fees, so it can lower costs for users. And since it's maintained by the provider, users can focus more on their core businesses.

Some analysts surmise that Oracle, which is based just a few miles away, might look to buy San Mateo, Calif.-based NetSuite if the small company continues its steady growth.

NetSuite last month, for the first time, brought in more cash than it spent on operations, says Chief Executive Zach Nelson, 42. He came from Oracle, where at age 31 he was the youngest vice president of marketing in Oracle's history.

Nelson expects NetSuite will become profitable by the second half of this year. He says sales tripled last year to $20 million, and he expects to hit $40 million this year. NetSuite plans to double its staff size to 300 employees by year's end.

"The world is changing to this hosted model because buying software is so expensive for the midmarket," Nelson said. "The idea is to bring an integrated application suite to small businesses and deliver those applications across the Internet."

NetSuite and Oracle maintain an unusual marketing relationship. NetSuite operates on its own, selling midmarket products under the NetSuite brand. But it licenses its low-end products as the Oracle Small Business Suite, for which NetSuite pays royalties to Oracle.

This gives Oracle a way to get to the small-business market. NetSuite defines small as companies with less than 100 employees, while midsize goes up to 500 employees.

"Oracle wants a footprint in small, growing companies that will one day grow up to use Oracle's databases and other tools," Nelson said. "This arrangement gives Oracle the small-business branding they never had."

Comforted By Big Ally

On the flip side, NetSuite gets to align with the world's second-largest software company behind Microsoft Corp. And Nelson can tap Ellison for advice as NetSuite tries to develop a new marketplace.

"Companies out there understand that we're aligned in a significant way with a very substantial organization," he said.

Hosted software companies - also known as application service providers or software utilities - are growing. U.S. sales of these products rose 35% to $2.3 billion in 2003 from $1.7 billion in 2002, says International Data Corp.

Perhaps the most high-profile hosting firm is Salesforce.com, founded by another ex-Oracle executive, Marc Benioff. It plans an initial public stock offering this spring. That could spur other software-hosting firms to follow suit, says Laurie McCabe of Summit Strategies.

"I think the Salesforce.com IPO will bust this market open," she said.

Nelson, though, says that if NetSuite seeks to go public, it wouldn't be until next year at the earliest.

"The Salesforce IPO can help us as long as it is successful," he said. "But our focus right now is to remain cash-flow positive and grow our business."

By being on its own, rather than a unit of Oracle, NetSuite will become a stronger company, says Robert Anderson, an analyst with research firm Gartner Inc.

"Larry Ellison could just throw big money at them and say make something happen," Anderson said. "But he hasn't done that, and over time that will benefit them."

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