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IP VPN: The Rising Star of Managed Services
31 August 2001 Charles R. Carr The growth in network complexity, driven by a need for more cost-effective integrated voice and data services, rapidly changing technology and a tight labor market capable of supporting next-generation networks, is forcing businesses of all sizes worldwide, and particularly in North America (United States and Canada), to seriously consider network outsourcing alternatives, such as carrier-managed public networking solutions. Data products offering only part of a comprehensive solution have been around for years, but the advent of MPLS/IP VPNs and ASPs/MSPs have focused a bright light on approaches that offer end-to-end public network solutions. The future is clear -- more enterprises will opt for carrier-managed network services that will extend through the LAN to the CPE and even the desktop. This Perspective discusses value proposition and growth trends of managed IP VPN in the context of other managed services in North America.
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# IP VPN: The Rising Star of Managed Services The growth in network complexity, driven by a need for more cost-effective integrated voice and data services, rapidly changing technology and a tight labor market capable of supporting next-generation networks, is forcing businesses of all sizes worldwide, and particularly in North America (United States and Canada), to seriously consider network outsourcing alternatives, such as carrier-managed public networking solutions. Data products offering only part of a comprehensive solution have been around for years, but the advent of MPLS/IP VPNs and ASPs/MSPs have focused a bright light on approaches that offer end-to-end public network solutions. The future is clear — more enterprises will opt for carrier-managed network services that will extend through the LAN to the CPE and even the desktop. This Perspective discusses value proposition and growth trends of managed IP VPN in the context of other managed services in North America.

Table of Contents
A Star Is Born Value Proposition Confusion Masks Transition Managed IP VPN Service What Is the Forecast Demand for IP VPN? U.S. Business Preference Canadian Business Preference Bottom Line: IP VPN Is a "Hot" Product And a "Cool" Revenue Generator

List of Tables
Table 1: | North American Managed Services Revenue (Millions of U.S. Dollars)

Key Business Issue How important are value-added services and managed data services in the public network service market? Strategic Business Assumptions Migration of business connectivity from private legacy-based WAN networks to managed public network services will be driven by the service providers and customers. Internally focused, "piecemeal" solutions and do-it-yourself approaches to complex networking challenges in the next five years will be detrimental to a business competitiveness (0.8 probability). Managed services will be a key new revenue opportunity for carriers over the next five years to offset margin erosion in native data services, improve product line differentiation and decrease their overall cost of network ownership (0.9 probability). Carriers will generate most of their managed services revenue through 2003 — and greatest margins after 2003 — from large enterprises rather than from the smaller businesses (0.7 probability). Beyond 2003, the greatest new revenue opportunity for managed services will be from small and midsize businesses that typically have a limited budget to ramp up and support internal telecommunications resources (0.7 probability). The importance of guaranteed QOS with strong nonperformance penalties and customer-verifiable SLAs are the "table stakes" for the managed services market through early 2003 (0.8 probability). IP VPN service revenue will grow at a 99.9 percent five-year CAGR to almost US$6.4 billion by 2005 (0.8 probability). A Star Is Born [return to Table of Contents] The future of telecommunication services is management. Migration from dedicated/private line wide-area networks (WANs) and native packet data services to a variety of managed public network services is the most prominent new trend in the North American telecommunications industry. Essentially, all carriers are looking to managed services to combat/offset the margin erosion in their native access and transport products, and retain enterprises customers. At a minimum, managed services provide business customers with tiered management, provisioning, monitoring and reporting functionality for their private, public or hybrid networks, and ideally, offer comprehensive capability to support myriad mission critical-network applications. Managed services come in a number of packages, offering a range of quality of service (QOS): from the relatively limited managed bandwidth services and managed edge device services — DSU/CSU/NID/IAD/router, through the more comprehensive integrated services offering various network-based applications, such as managed multiprotocol label switching (MPLS)/IP virtual private networks (VPNs), managed WAN data services — asynchronous transfer mode (ATM)/frame relay/private-dedicated line/IP, and managed network/local-area network (LAN) services. While managed network solutions have been around for years, the attention over the past year has been focused on next-generation managed services implementations. Specifically, MPLS/IP VPN services are clearly the rising stars of the managed services group, gaining strong acceptance as a preferred method of building cost-effective and secure future business networks. However, most enterprises are still only partly aware of the benefits and capabilities of managed implementations, particularly IP VPNs. Value Proposition [return to Table of Contents] The most compelling benefits of managed services are shifting the risk of technology investment/network operation to the provider and future-proofing the network. The benefits to carriers are also real and immediate — product differentiation, higher margins (into triple-digit growth percentages) and more effectively leveraging network investments by bundling numerous value-added services over the same fixed-cost infrastructure. While no single provider needs to own every component of the end-to-end solution, they must have access to the underlying "factory" to deliver competitive managed services. Partnering, merger with or acquisition of specialty service providers, such as independent management service providers (MSPs) and application service providers (ASPs), will be a near-term necessity for all next-generation providers and competitive local exchange carriers (CLECs) and smaller incumbent local exchange carriers (ILECs) to provide a complete solution. The importance of meaningful guaranteed QOS and service-level agreements (SLAs) that provide customer-verifiable measures cannot be understated. These are the carrier's entry fee "ante" to this market segment — even relatively minor improvements/differences can result in major impacts on uptake rates, branding, margin and revenue. Representative of a new class of IP-based services is the MPLS IP VPN service, such as that offered by Bell Canada with multiple guaranteed QOS tiers matching quality to the type of traffic transported — standard for e-mail/FTP/noncritical Web applications through near real-time class SLA for voice over IP (VoIP)/video-conferencing applications. Global Crossing is another tiered QOS offering that is based on the criticality and delay sensitivity of the specific type of application. The value is clear but the downside for businesses is also real and is summed by the actual or perceived loss of control of some or all network operations by the business' IT/telecommunications/network manager. This is why moving mission critical responsibility/traffic to a single outsourced/managed solution from an existing, stable, internally managed environment will be a gradual and evolutionary process, particularly considering the still evolving networks and often unstable QOS or questionably verifiable SLAs. This concern must be mitigated by establishing a strategic partnering relationship vs. a vendor/client or a systems outsourcing relationship. Confusion Masks Transition [return to Table of Contents] Confusion still surrounds the managed services market because of the reliance on marketing/public relations (PR)-driven approaches to defining these services, which often focus on the use of the hottest terminology rather than on key differentiation of core functionality and features. Gartner Dataquest segments the managed services market into four functional/market categories: management of edge device, managed IP VPN, managed WAN, and managed network/LAN. Only the IP VPN service is discussed in this Perspective. A more complete analysis of the managed services segments is provided in the Gartner Dataquest Focus Report titled "North American Managed Services: Telecommunications' Future" (TCPS-WW-FR-0110). Managed IP VPN Service [return to Table of Contents] Simply, VPNs emulate the full range of private WAN functionality using existing, underlying access and backbone transport technology to fully exploit the economies of scale of the underlying network infrastructure by segregation of communications over a carrier-operated, shared (public) network for a closed (well-defined) community of interest. VPNs are viewed exclusively as the implementation of a secure end-to-end connection through a shared, purpose-built IP or the public IP (Internet) network. IP VPN offerings take several architectural forms depending on their intended use: remote access, internal enterprise networking (corporate intranets), or business-to-business networking (corporate extranets), but they deliver a common set of features. IP-based VPNs, depending on system requirements — scalability, implementation complexity, and ongoing operation and maintenance — can reside at different layers of the transmission control protocol (TCP)/IP suite — link layer, network layer, transport layer and application layer. IP VPNs (Network — Layer 3), the most dominant type going forward, offer affordable, worldwide network reach, but at present lack proven reliability, tunnel manageability, scalability and end-to-end management. Management features commonly include fault management, configuration management, edge-to-edge SLAs, security management and limited network operations monitoring/reporting capabilities. QOS is a continuing challenge for IP VPNs, which in the past was addressed by controlled load edge-to-edge traffic profiles using a mechanism that loads per-flow state into the switching elements of the network. A recent major step in solving the service quality gap for IP-based services was the introduction of standard-based switching technology based on MPLS, which improves IP network traffic engineering by helping to streamline the traffic pathway (traffic isolation) and permitting the establishment of traffic classes for tiered levels of service quality. MPLS allows overlaying protocols (Layer 2 ATM and Layer 3 IP) and the migration of many functions of the ATM control plane to Layer 3, simplifying network management and complexity and eliminating the ATM "cell tax" with carrying IP traffic. Finally, VPNs can be built on demand by creating IP "tunnels" through a network using MPLS without having to use encryption IP security (IPSec), but IPSec can be used in tandem — deployed in an MPLS environment for sensitive data that must be encrypted end to end. What Is the Forecast Demand for IP VPN? [return to Table of Contents] Overall, North American managed service revenue growth, particularly in Canada, will significantly outperform other data service revenue growth (see Table 1). Revenue forecasts estimate recurring revenue from services only. These forecasts are supported by primary end-user demand-side research and service provider research over the past year. Hardware/equipment and software costs are not included in these forecasts.

Table 1
North American Managed Services Revenue (Millions of U.S. Dollars)
[return to List of Tables]
| 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | CAGR (%) 2000-2005
Managed IP VPN Services
| 15.4 | 200.1 | 730.8 | 1,704.9 | 3,312.9 | 5,171.0 | 6,378.5 | 99.9
| End-User Managed Service
| 0.8 | 12.0 | 51.2 | 136.4 | 298.2 | 517.1 | 637.9 | 121.3
| Transport Managed Service
| 14.6 | 188.1 | 679.6 | 1,568.5 | 3,014.7 | 4,653.9 | 5,740.7 | 98.1
Total North American Managed Services (IP VPN, WAN, Network/LAN and Edge Device)
| 4,548.2 | 6,769.8 | 9,755.3 | 13,399.6 | 17,686.0 | 21,767.6 | 24,564.1 | 29.4
| End-User Managed Service
| 1,512.1 | 2,236.7 | 3,126.1 | 4,109.4 | 5,088.3 | 5,946.4 | 6,525.8 | 23.9
| Transport Managed Service
| 3,036.2 | 4,533.1 | 6,629.2 | 9,290.2 | 12,597.7 | 15,821.2 | 18,038.3 | 31.8
Notes: End-user managed service revenue — End-user location side managed revenue component of managed service revenue which may include managed LAN and managed edge device revenue. Transport managed service revenue — Access and transport side managed revenue component of managed service revenue. Equipment cost and professional services associated with managed services (such as consulting) are not included in revenue. Source: Gartner Dataquest (August 2001)
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U.S. Business Preference [return to Table of Contents] Overall, managed services have gained a significant foothold in the U.S. midtier business market, particularly the relatively young IP VPN in the smaller midtier market and the managed network/LAN service in both midtier segments, against well-established managed WAN services and relatively simple managed edge device services. Managed network/LAN service is the clear favorite with 56 percent penetration of the middle and large business markets. IP VPN service is a strong second preference (41 percent) and growing. Of companies that believe they will subscribe over the next 12 months, IP VPN service is the dominant favorite in both midsize segments — 43 percent in small and 57 percent in large midtier categories (45 percent overall) expect to subscribe to IP VPN service. The top driver/need for businesses selecting a managed service option are similar across size categories — improved network availability (as evidenced by the increase in the number of carriers providing various managed services) and service reliability. Operating cost reduction credited to the use of managed services/solutions was pronounced — a 20 percent to 25 percent reduction. Some of this cost reduction difference may be because of the more extensive and complex (and correspondingly more costly) feature set utilized by the larger companies. Canadian Business Preference [return to Table of Contents] Overall, managed services have gained a strong foothold in the Canadian midtier business market, particularly the relatively young IP VPN service in the small midtier business market, against well established managed WAN services and relatively simple managed edge device services. IP VPN service is the clear favorite, with 47 percent of midsize and large enterprises having implemented IP VPNs. Of the companies that believe they will subscribe over the next 12 months, IP VPN service is preferred — 42 percent expect to subscribe to IP VPN service. Specifically, in the managed WAN services category, managed IP services are by far preferred (71 percent of companies responding) going forward over any other type of managed WAN service. The primary drivers/needs for Canadian businesses selecting a managed service option are consistent across size categories — improved availability (as evidenced by the pickup in the number of carriers providing various managed services) and service reliability, followed by improved network operating efficiency and network security. Operating cost reduction credited to the use of managed services/solutions was pronounced in both midtier categories — a 13 percent to 19 percent reduction. Some of this cost-reduction difference may be because of the more extensive and complex (and correspondingly more costly) feature set utilized by the larger companies. Bottom Line: IP VPN Is a "Hot" Product And a "Cool" Revenue Generator [return to Table of Contents] The future direction of enterprise networking, no matter what the underlying technology, is clear — managed services. Internally focused, piecemeal solutions and do-it-yourself approaches to this complex, integrated networking/application challenge in the long term is an unworkable formula for success and is ultimately detrimental to an enterprise's competitiveness. Business customers must fully focus on their core business to compete and must minimize their investment risk exposure in new technology. These objectives are not compatible with a business trying to internally design, implement, update/modify and maintain their own networks in our rapidly changing and increasingly complex telecommunications world. Consequently, private line networks and native packet data solutions offered alone without an umbrella of management features will be increasingly hard to sell to business. Going forward, networking technologies (access or transport) will increasingly be meaningful only when bundled as part of an integrated part of a managed end-to-end communications solution. IP VPNs, particularly with the introduction of MPLS-based technology, will gain acceptance quickly as one of the preferred methods of building managed networks, but most enterprise users are only partly aware of the wide range of benefits and capabilities of most managed implementations and the large number of carriers that provide these services. To realize the full managed services opportunity, carriers must do a better job communicating not only the present but also the future-proof value proposition, capitalizing on the high initial interest shown in this solution. In the end, success will depend on the carrier acting more as a long-term partner with the customer than simply a vendor to the business — delivering value beyond simply technology as part of a transparent network, such as service customization, "high touch" customer support/care program with a single point of contact, and compelling consolidation of vertical market applications on a single network. Managed services will provide one of the largest new revenue growth opportunities for carriers over the next five years, and will significantly help them offset margin erosion/price commoditization in their native data services, improve product line differentiation and brand, and decrease their overall cost of network ownership. Carriers that are not already on this development/deployment curve (through acquisition, partnering or grassroots development) will find themselves minimalized in the future marketplace — forced to play exclusively in the commodity space, essentially wholesaling bandwidth, or worse, go out of business. However, the adoption of managed services, particularly IP VPN, will not be without challenges to the service provider that include near-term guaranteed performance/service quality.

This research is part of a set of related research pieces. See AV-14-4056 for an overview.

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