(FORTUNE Magazine) – Outside, the building could not be more ordinary--it's indistinguishable from hundreds of other offices dotting Silicon Valley. You'd never suspect that inside are computers running services, like Hotmail, Lycos, and Corio, that are helping turn the business world upside down. Step through the front door, and the contrast is even more striking. Where is the boldly colored corporate logo, the svelte young receptionist with the pierced navel, and the ultramodern furniture that every highflying Internet firm displays? Here, you find only a grim-faced uniformed guard seated behind a shabby desk, a nondescript sign reading EXODUS, and a few uncomfortable-looking chairs. The place may as well scream Go Away.

Isolation would suit Exodus Communications just fine. The company doesn't give out the street address of its Santa Clara, Calif., Internet data center--one of 12 it operates in the U.S. "Security reasons," says co-founder and chief technology officer B.V. Jagadeesh. Only after you pass a second guard desk and a locked door do you get at the heart of Exodus. You hear it first: the loud hum of powerful air conditioners, laboring to keep the room full of computers from overheating. Then you see row upon row of 84- by 19-inch metal racks, each holding as many as seven computer servers--some 2,500 servers packed into the 55,000-square-foot data center. Fiber-optic cables from six companies (including AT&T, MCI WorldCom, and Pacific Bell) connect to these servers, providing redundancy should any cable go down. Three backup diesel electrical generators, each capable of producing a megawatt of power, stand ready should the power fail. Proprietary Exodus software monitors the computers and networks.

The racks of computers are secured in locked, black chain-link cages. Each cage powers a different company. Lycos, the Web portal company, has a 2,700-square-foot cage. Every time a user hits lycos.com, he taps one of the computers racked inside Exodus. Customers of Lycos' archrival Hotmail are routed to computers in an equally large cage just across a three-foot aisle. On the second floor, Exodus is building a cage that at 5,800 square feet will be its largest yet--for Microsoft. What sort of software will reside there? "It's a secret," says Jagadeesh.

Certainly Microsoft could replicate all this on its own. Instead, it and other Web-savvy businesses are using the Internet to eliminate the burden of buying and running expensive, hard-to-maintain computer systems. They're turning to outsiders like Exodus for a wide range of services, from playing host to corporate accounting, personnel, and payroll programs to gaining quick entree to the world of e-commerce.

The Internet liberates businesses from doing their own computing in much the same way grocers free households from baking their own bread and churning their own butter. Capitalizing on the fact that millions of employees, customers, and suppliers now have access to the Internet via their Web browsers, whole new classes of companies have begun to emerge--along with a thick alphabet soup of acronyms for the kinds of computing they supply, including ASP (application service provider), BSP (business service provider), and CSP (computer service provider).

The differences between the three types of providers get pretty convoluted, as companies attempt to straddle more than one area. But here's the idea:

--ASPs license, maintain, and rent software systems--such as accounting and human resource programs--written by other companies, for a broad range of business clients.

--BSPs are a new breed of software developer providing a suite of services for rent, often tailored to one industry, like airlines or banking.

--CSPs (like Exodus) are essentially server farms that house equipment for ASPs, BSPs, and e-commerce businesses. They supply computer power in much the way that a utility supplies electricity, allowing customers to "plug in" their software. Think of it as outsourcing for the dot.com crowd.

Jargon to the side, Web services are exploding. Exodus has had quarter-to-quarter revenue growth of more than 40% in the past two years and plans to open nine more data centers by year's end. CEO Ellen Hancock says that her company is adding two customers a day.

The entire Web services business seems ready to follow suit. For example, the ASP business is tiny now--companies did a meager $150 million in sales last year--but it should grow to $2 billion in 2003, says Clare Gillan, an analyst at International Data Corp. in Framingham, Mass. (She can claim the dubious distinction of having coined the term ASP.) Lewis Wilks, president of Internet and multimedia markets for Qwest, thinks Gillan's forecast grossly underestimates the market's potential. "It's going to grow a lot faster than we thought possible," he says.

The proliferation of service providers has given rise to some tangled arrangements. Take the case of Corio, an ASP in Redwood City, Calif. It uses computers at Exodus to run financial software it has licensed from PeopleSoft, a developer. Corio rents the use of the software to customers like the Internet portal company Excite, also in Redwood City. Using Web browsers, Excite's accounting staff accesses the PeopleSoft application in the Corio cage in Exodus' Internet data center in Santa Clara, 30 miles away. The setup requires elaborate business arrangements among Exodus, Corio, and PeopleSoft. But it simplifies things for Excite, which otherwise would have had to license the costly application from PeopleSoft, buy the computers, storage systems, and networking equipment on which the software runs, and hire experts to install and maintain the whole thing.

Instead, Excite simply pays a monthly fee for Corio's service. Charges to rent a PeopleSoft application from Corio range from $10 for a self-service user (e.g., an employee who uses the program to find out, say, how many sick days he is allowed) to $795 for an active user (an accountant who uses the application daily). That can add up to savings of 30% over five years, promises Jonathan Lee, founder and CEO of Corio.

Corio rents out only two applications; other upstarts, like USinternetworking, offer customers entire software suites. Hewlett-Packard Chairman Lew Platt has nicknamed such services "Apps on Tap," since they enable companies to plug in to a set of services, ranging from payroll and accounting software to inventory programs specifically designed for their industries. (See the list later in this story.) One BSP, Tibersoft, has created software for the food-distribution industry that connects vendors, distributors, and restaurants. Sysco, the largest distributor of food products in the U.S., with $15 billion in annual revenues, recently adopted Tibersoft software. Its 300,000 customers can now order supplies, schedule deliveries, and track the progress of their orders using a simple Web browser. They don't have to install any software on their own computers, since the programs that power this service run on machines at--you guessed it--Exodus.

Internet outsourcing has captured the imagination of software entrepreneurs. In June, Norwest Venture Partners, a venture firm in Palo Alto, held its annual Software Forum at the tony Hotel Sofitel in Redwood City. Past meetings explored such issues as how to build a direct sales force, crack the FORTUNE 500, or maneuver around business software giant SAP. While all are important topics, they're passe. This year, when entrepreneurs assembled from 32 Norwest-funded business-software startups, the buzz was about Internet business services. "Most of our enterprise software companies are moving in this direction," says Promod Haque, a partner at Norwest. "If they aren't yet, they will be soon." Yogen Dalal, a partner at Mayfield Fund, a Menlo Park, Calif., venture capital firm, agrees: "VCs are no longer funding traditional application software companies selling $100,000 to $500,000 enterprise applications." Mayfield continues to get business plans from entrepreneurs wanting to create such firms, he adds, but "we say, 'Guys, it's a great idea, but think about how to deliver it as a service, not sell the application.'"

Blue-chip software firms have gotten the message too. The week before Norwest's gathering, $7.1-billion-a-year Oracle held a similar event, dubbed "e-Business Day," at its Redwood City headquarters. It was a coming-out party for Oracle's new Internet-based software and services. Among these is Oracle Business OnLine, a service allowing customers to use Oracle applications over the Internet instead of installing the applications on their own machines. CEO Larry Ellison is wildly enthusiastic about the change. "No [customer] wants this complexity in their shop any more," he says. "Running computers isn't fun." Offering software services via the Internet also helps Oracle reach small businesses, which in the past would not buy costly enterprise software. Oracle is a bit unusual because it rents the software to clients itself rather than contracting out to an ASP. "No one knows the application better than us," says executive vice president Gary Bloom. "We think customers would rather rent the application from the application developer."

Meanwhile Qwest and EDS have made themselves into combination ASP and CSPs for SAP, the $5-billion-a-year German enterprise software giant. (Enough acronyms for you yet?) Each licenses SAP's software and runs computers operating the program, enabling customers with Web browsers to tap in. Like Oracle, SAP embraces Web services as a way to reach the small business market. Says Kevin McKay, CEO of SAP America: "These are customers that didn't consider SAP before."

Even as big players enter the ASP business, it will trail traditional software licensing for the foreseeable future, largely because conservative business customers want to make sure such arrangements work before they farm out crucial business functions. That is, if they ever do. "Many companies are simply unwilling to risk having their most sensitive data outside their control," says Tom Siebel, founder and CEO of Siebel Systems, a San Mateo, Calif., supplier of sales-force automation software. He is one of the few software executives openly skeptical of the ASP approach. "There are true believers out there; I don't happen to be one of them," he says. Siebel Systems has a 5% equity stake in USinternetworking, a combination ASP and CSP that offers Siebel software for rent, but, says Siebel, "quite honestly, it's not something that our customers are asking for." USinternetworking has signed only a handful of customers since January, when it began offering the software, vs. 1,000 customers that have purchased the application.

Siebel's skepticism is understandable; there are major--and valid--concerns about the ASP business. However, a glimpse at the computer industry's past hints that ASPs may well become wildly successful. Just 25 years ago, many business customers used to rent time on computers and programs rather than buying them outright, in a practice known as time-sharing. The computers, operated by third parties and located at remote locations, could only be accessed through special dedicated terminals. Talk to industry graybeards about ASPs or BSPs, and they inevitably say they're reminded of the early days of computing. "It's back to the future," says Nick Earle, senior vice president and chief marketing officer for Hewlett-Packard's enterprise computing division.

Time-sharing helped spawn the first generation of BSPs, data-processing companies like Automatic Data Processing, the $4.8-billion-a-year leader in payroll check distribution. It and other first-generation BSPs are thriving today and adapting to the Internet. Gelco, which handles travel expenses for 2,000 companies, has licensed Internet software from Extensity of Emeryville, Calif., that manages travel and entertainment expenses.

Web services will have wide-ranging impact on the software industry. The biggest effect will be on the way software companies accrue revenue. If you want to know what the business version of hell looks like, just hang out at a software company during the last few weeks of a quarter. Customers often wait until the end of the quarter before signing a deal, which gives them a bit more of an edge when negotiating prices; the end-of-quarter heat on the sales team to close the deals is intense. Renting software to ASPs relieves some of the pressure; such arrangements generate recurring revenues that are easier to predict and manage. Software companies like that--as do investors. "We'd love to see more of an annuity model," says Charles Phillips, Morgan Stanley Dean Witter's top business software analyst.

That's great for software companies but brings enormous risk to the ASPs. Though they try to tie in customers with multiyear contracts, the generic applications they provide--e-mail, for instance--can be easily replaced, says Pehong Chen, founder and CEO of BroadVision, an e-commerce software company in Redwood City. Here BSPs may have an advantage, since their systems often become so tightly integrated into a customer's business that they're difficult to change.

With customers wielding newfound power, software companies will be forced to pay much greater attention to customer satisfaction then they ever have before. In the past, once the salesperson sold the software license, he was on to the next deal. The customer had paid out so much money it was not about to switch vendors unless the software failed completely. In practice, this meant that software companies often shipped applications knowing that they had significant bugs. Now the poor level of service in the software industry will have to end. "Things that used to be a bug are now reasons to leave," says Bo Holland, founder and CEO of Works.com, a procurement service provider in Austin, Texas. "[The advent of ASPs and BSPs] is probably good medicine for the software industry."

If this is medicine, it must be pretty potent, because the business software market is alive as at no other time in its history. Only a couple of years ago there was concern that the industry would stagnate as it became dominated by large firms like Microsoft and SAP. Instead, the Internet has unleashed a surge of activity as new companies pursue a wide range of opportunities. "There's going to be a reshuffling of revenues [in the business software market] on a large scale," predicts Dalal of the Mayfield Fund. That's good news for venture capitalists, and even better news for business software customers.