ASPs (Application Service Providers) deliver on-demand information processing services to user firms through the Internet. Due to rapid technological developments in telecommunications in recent years, the use of ASPs has become an attractive alternative to purchasing, installing, and maintaining modifiable off-the-shelf (MOTS) software solutions. We study several critical aspects of a user firm's choices between an ASP and MOTS software. The competitive model considers heterogeneous users who differ in terms of their expected transaction volume, while the ASP and MOTS vendors differ in terms of their pricing structure, setup cost, data integration ability, and service level arrangement. Our results identify and characterize the equilibrium conditions under which ASPs and MOTS vendors can coexist in a competitive market, and they explain which firms could be the primary beneficiaries of each vendor type. We find that the cost of integrating preexisting IT systems with an ASP's data flows is an important determinant in predicting the competitive advantage of the ASP. ASPs' ability to compete with the MOTS vendors monotonically decreases with the cost of integration. When the integration cost exceeds a certain threshold level, the MOTS vendors take over. On the other hand, the competitive advantage of the MOTS approach decreases significantly with the transaction volatility of the users. Although users of the MOTS software expect to incur significant loss due to transaction volume volatility, users of ASPs shift such risks to their vendors. For the settings we study, we conclude that the value added by ASPs comes from the efficient pooling of transaction volatility risks as much as from the reduction in significant IT implementation costs. In addition, using an extended dynamic competition model, we show two-fold effects of users' switching costs on the market outcome. We find that under certain market condition the ASP should strategically remove its users' exiting barrier to increase its competitive advantage. In such case, an optimal ASP contract should promise users an easy exit with low costs, instead of demanding users' long-term commitment.