Tier1: Higher Prices Ahead for Data Centers

Will 2009 be a huge year for enterprise data center outsourcing? It will if enterprise companies understand the pricing outlook for the data center market, according to Dan Golding, vice president and research director of Tier1 Research. Demand for data center services has declined only slightly, Golding says, while the amount of new supply has been constrained by the credit crunch. The tough economy has led many many providers to hold pricing steady, but that trend won't hold as the supply-demand imbalance continues to deteriorate in major data center markets, particularly if the economy improves.

"I think we're going to see data center prices increasing significantly in the third and fourth quarter," Golding said Tuesday in his keynote at Tier1's first Datacenter Transformation Summit in Herndon, Va. "We think we're going to see 7 to 10 percent price increases annually until credit eases, plus another 18 months (to fund and build new data centers). This is good for providers but not for enterprises. Now is the time for enterprises to lock in. There are lots of things you can get a discount on by waiting. Data centers are not one of them."

The impact of the credit crunch on supply emerged as a challenge in early 2008, even before the financial crisis worsened in September. Tier1 has been predicting that a shortage of quality data center space could lead to higher colocation prices, although pricing impacts will vary among market segments and geography, Golding said. "There are specific markets where you can get deals as providers seek to meet bank covenants," he said, referring to loan agreements in which repayment terms are linked to leasing success.

The outlook for data center providers is strengthened by the growing expense and complexity of building and operating data centers, which is reinforcing the value proposition for enterprises to move some of their IT operations to third-party facilities.

Building data centers "is a really bad idea for about 95 percent of the people engaging in this activity," said Golding, who said the cost of building a new facility is approaching $2,500 a square foot. "It's not a win for most companies. Enterprises no longer have the CapEx (capital expenditure budget) to build their own data centers. It's driving people to third-party data centers."

While a growing number of enterprises use colocation and "wholesale" data center services, many large companies are either not aware of the benefits of outsourcing data center operations, or deterred by "doomsayers" with notions of risk rooted in the industry crash of 2001.

"We feel very strongly that the third-party data center is a valid option for enterprises," said Golding. "This is not 1999 or 2001. The providers of these services are stable, and it's a stable market."

Golding says memories of the last downturn continue to influence key players in the supply side of the data center equation. "Banks hate data centers," he said. "Banks remember 2001," when bankruptcies by large providers like Exodus, WorldCom and AboveNet battered loan portfolios of banks. That has made it difficult for data center projects to get construction financing, drastically reducing the inventory of new space.

Golding said the value of third-party data centers is reinforced by the "stickiness" of these business relationships. Shifting IT operations between data centers can be challenging. Providers that deliver strong service find that customer loyalty drives strongr ecurring revenue.

"Data centers are like a roach motel," he said. "Once you check in, you never check out. Once you try this, you're never going back to your own data center."