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I have been googling a lot to find the installation guide on how to install Reporting Services on a application server, but couldn't find anything. I already have an SQL server on another machine and want to use this server to host the reporting databases.

On my own application server, where I am trying to install Reporting Services, I am not quit sure what to choose/configure for Instance ID and Instance Root Directory which is the page that comes right after the Feature Selection in the SQL Server 2008 R2 Installation wizard.

So how to I proceed with this?

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I think that you want to look at "Configuring Reporting Services Scale-out Deployment", which used to be called a SSRS "web farm".

In this scenario, you can install a number of SSRS web sites that all reference the same metadata databases on a common, central SQL Server. You can install just one "farm" server or many farm servers, in addition to the central SQL server. You can use NLB or not use it. The load of the reporting servers is generally very light compared to the load on the servers that are the target of the actual reports. A small box can usually handle a fairly busy SSRS site.

You must have Enterprise Edition and there are likely licensing considerations.

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