How the Smallest Survive The little guy in a commodity business, Rackspace hits 'em where they're most vulnerable: Service.
By Om Malik

(Business 2.0) – Where have all the Web hosting companies gone? At the height of the dotcom era, there were nearly a thousand of them, ranging from Exodus, once valued at $80 billion, to Intel Online Services. Now there are about 200, handling the Web operations of thousands of companies. So how did San Antonio-based middleweight Rackspace make it to profitability, surviving alongside such powerhouses as AT&T, EDS, and IBM? One word: Service.

In many ways, the story of Rackspace is a lot like that of its neighbor up Interstate 35, Dell. It's no coincidence: CEO Graham Weston deliberately attempted to replicate the Dell model. Each company took a product that was becoming commoditized and trounced the competition by offering expert support--cheap. Founded in 1998, privately held Rackspace now has 375 employees and a comfortable $11 million in cash. Sales at the end of 2003 were up almost 50 percent over 2002, outpacing an industry that grew about 10 percent.

Like a lot of dotcom-era survivors, Rackspace caught a lucky break: It launched just as its competition was starting to self-destruct. Intel Online Services, Exodus, and Genuity, as well as the Web hosting arms of Cable & Wireless and Sprint, accumulated mountains of debt by spending millions building their own data centers in expectation of a deluge of dotcom business. But when the dotcoms crashed, that business never came, and many of the big Web hosts themselves died. That created a double opportunity for Rackspace, which could buy data centers and extra bandwidth cheaply. "We only built what we needed," Weston says, "and did not spend a penny more."

It took discipline to stay in business after the crash. Weston cut 10 percent of his workforce and 70 percent of the company's $12 million annual marketing budget, not to mention the free soda and candy in the cafeteria. The bleeding largely stanched, he automated work flow with proprietary software so only a few staffers could manage thousands of servers. (The only manual work is putting a server on a rack in the data center, usually done in less than 30 minutes.)

That move may sound banal, but it was critical: With fewer people on server duty, more employees could be dispatched to deal with customer problems. Weston also had an epiphany while watching a video of an Australian pet store mogul who sold more parrots than anyone else by guaranteeing that they wouldn't die. Weston realized that customers were less afraid of a system crash than of not being able to get someone to fix it. His reassurance? He gives every client his cell-phone number, as well as those of all other executives on sales or support calls.

Finally, Rackspace stuck to its knitting: Web hosting service is all it provides. That appeals to customers who are suspicious that bigger players offer Web hosting as a kind of loss leader. The telecoms, claims Joel Reimer, website manager at gardening supplies company Scotts, give away Web hosting as "a way for them to get into the account. Rackspace is about managed Web hosting, and Web hosting only."

The next move? Probably not a buyout from one of the giants. Weston says he wants to be one of those big boys. With pre-tax earnings of $12 million on $58 million in revenue, Rackspace's money can be put to use--buying the discounted assets of less agile rivals. -- OM MALIK