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Special Report: SAP-ping credibility

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29th Jan 2007
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By Stuart Lauchlan, news and analysis editor

It’s a bit early in the year for midsummer madness so we’ll just have to put it down to fiscal form of seasonally adjusted disorder, but whatever the underlying reason the inevitable finally happened this week: the investment community got it into their collective heads that Oracle was going to make a takeover bid for arch-rival SAP!

“There's talk that Oracle will bid 38.5 eur per share for SAP,” one London-based dealer was quoted as saying, seemingly oblivious of the anti-trust hell that would break loose in Justice Department and European Union circles before the ink was dry on the tender documents.

Assuming as we must that Larry Ellison is a bit more savvy than that and charitably dismissing the mischievous thought that he might just have a pop at a takeover bid just to show the world that he can afford to, then the question has to be asked: how have we gotten to the stage where the market darling SAP can seriously be thought to be vulnerable to a takeover by Oracle?

Yet that seems to be what happened – SAP’s shares soared as greedy investors dived for a slice of the action once the rumours began to circulate on Monday afternoon, so someone somewhere believed it! The clue probably lies in a series of announcements that the Walldorf-giant has made in recent weeks, climaxing with the news that it had fallen short of its revenue targets and would be investing heavily in a new direction for future growth.

It’s hardly a suggestion that the 'for sale' sign is about to be put up outside the headquarters, but for a market-leading ship of state like SAP any indication of an unexpected variation from the norm is going to set alarm bells ringing, rightly or wrongly. The noises from SAP this month have been a long time coming and in all honesty are scarcely that shocking – but they’ve rattled some nerves and the end-result is investor credulity.

So what’s the real story? Well there is a financial issue. Last year's revenues rose by 10 percent, to 9.4 billion euro, versus 8.5 billion euro in 2005. Net income came in at 1.9 billion euro, 25 percent higher than the 2005 figure of 1.5 billion euro.

Operating income for 2006 was 2.6 billion euro, 10 percent higher than the 2005 figure of 2.3 billion euro, but operating margins fell one-tenth of a percent compared to 2005, from 27.4 percent to 27.3.

SAP also cut its reported 2006 license sales by 30 million euros, meaning that licence sales grew by only 12 percent instead of the reported 13.5 percent at constant currencies, well short of SAP's targeted 15 percent to 17 percent growth.

The company has ambitious goals still. By 2010, it wants to get 50 percent of its orders from new products, have two thirds of its installed base on enterprise SOA and have 100,000 customers, up from 38,000. Smaller customers, who in theory would have an easier time implementing SAP, would bump up the numbers.

"According to our SAP contacts, management has told employees that the company's future is in the middle market since the high end is relatively saturated,” reckons William Blair analyst Laura Lederman. “These costs signal to us that growing in the middle market will cost more than targeting SAP's current enterprise market."

Henning Kagermann, SAP's chief executive officer, said that in the next two years the company would spend between 300 million and 400 million euros on another assault on the small and medium enterprise market that has to date eluded it. SAP defines the SME market as companies with fewer than 2,500 employees and less than 500 million euros in annual revenues, which has previously been unable to afford high end SAP applications or indeed to need its deep functionality.

Software as a service

The key to the latest bid for success lies in the software as a service (SaaS) model which SAP has to date shown little enthusiasm beyond an acknowledgement that it needed to tick the box in that space. Now however it is seen as the key to cracking the SME market – ironic given that the pureplay SaaS vendors are increasingly focused on trying to crack SAP’s traditional high-end market!

The A1S suite, also known as 'Project Vienna', is a set of preconfigured mySAP software that can also be deployed as a service over the internet to give customers the option of buying it or renting it. It will initially be offered as a service this year, and then as a licensed product in 2008 for internal servers.

"We have an exciting new opportunity to invest in a new market for us - into an untapped market for us, the mid-market - and we need come investment for this because SAP is an innovator, we don't acquire companies," explains Kagermann. "We believe this is a game-changing product... with a lot of breakthrough innovations."

But Kagermann is being cautious about how soon SAP can expect to a see a serious return on its SaaS/SME gambit. He reckons that the company is looking at two years of marketing investment in the A1S product, with returns not really showing up until year three. But the prize will come in year four, if he has his sums right, and SAP could be looking at margins that are larger than it currently has with the current mySAP and Business One products.

So how serious is he? Is this just another piece of bravado? The key here probably lies in the wording of his statement of SAP’s goals. Remember that ambition of seeing SAP add 10,000 new customers per year, versus 2,000 per year today? That leads Kagermann to a painful conclusion: “You cannot do 10,000 new customers with mySAP." But of course you might just manage it with a hosted, easy to install option.

So can they do it? “I love big, audacious goals and SAP’s plans to end 2010 with 100,000 customers, certainly qualifies. I’m not sure it can be done, though,” reckons Bruce Richardson of AMR Research. SAP is going to need to average more than 15,000 net new customers for the next four years. Most of the 62,000 will come from small companies.

“If I did the math correctly, SAP’s 9,480 partners sold All-in-One to 1,180 companies. Even subtracting out the 940 that were new in 2006, most partners are selling less than three accounts a year. BusinessOne resellers are more successful. The 1,300 partners sold 2,000 accounts during the second half. A myth endures that there is a huge indirect market waiting for the right product. While the sheer number of SAP or Microsoft resellers is impressive, most don’t sell anything or very little.

“While our early reactions are very favourable, SAP has minimal revenue expectations for the new product this year. In my view, A1S represents the future - model-based development, Web 2.0, native web services, all new software - no repurposed R/3 code. In many ways, this is SAP’s answer to the hydrogen car.”

Richardson wonders if the new offering could lead to demands for some of the functionality to be built into the existing customer base. “I would bet that the larger accounts will begin demanding more of the newer technology featured in A1S. After all, who wouldn’t want a product that 'eliminates buyer’s risk,' provides a 'faster time to market' and 'reduces total cost of ownership by up to 90 percent'? Do you sell the sizzle or the steak?”

Skill sets

One thing that the new strategy will do is give a boost to the likes of Salesforce.com and NetSuite who have previously found elements of the SAP installed base unresponsive, at least partly because SAP was not openly supportive of the SaaS model. On the other hand, now that SAP says it’s a good idea…

Netsuite CEO Zach Nelson says this was SAP’s 'IBM moment', an allusion to the validation that IBM gave to Oracle in the relational database wars of the early 1990s. "Larry Ellison once told me that the best thing that happened to Oracle in the early days was IBM’s pre-announcement of a relational database years before it was available,” he explains. “It gave credibility to the then-new idea of relational databases and created demand that IBM could not fulfill.

“SAP’s announcement will cause confusion within their customer base and sales organisation while it creates demand for a solution that only NetSuite has. We are watching the evolution from Stone Age solutions like SAP, Microsoft and Intuit to the Internet Age solution of NetSuite at an even faster pace than we could have anticipated. It doesn’t get much better than this!”

The other factor that might be causing some stirring among investors is the long-term uncertainty about who will be executing on the new strategic direction for SAP. Kagermann’s contract as CEO is due to finish at the end of this year and to date no-one knows if he wants to stay on long-term. It’s an open secret that on 15 February an interim fix will be put in place whereby he will be offered a one year extension to the existing contract that he will almost certainly take up.

But remember, it’s three to four years before the new strategy starts to deliver in any meaningful sense, so the question of Kagermann’s potential successor becomes increasingly interesting as he or she will almost certainly have to execute the current CEO’s vision. Again, this is potentially a storm in a tea-cup as the two most obvious candidates are internal SAP execs - Shai Agassi, president of the product and technology group, and Leo Apotheker, president of customer solutions and operations.

The two men have different skills sets to offer. Apotheker is a safe pair of hands, a good company man and strongly associated with the current SAP management team, but maybe perceived as a touch conservative and not having demonstrated any particular technology flair. On the other hand, Agassi has youth on his side, is tech-savvy and an accomplished and slick public performer, skills that would come in handy when going head to head in a grandstanding competition with Marc Benioff or Larry Ellison.

Both men are coy about their ambitions. "What I hope to have happen is that Henning extends his contract because I think the current team is a fantastic team," Agassi has said, while Apotheker stated: "I am fully committed to our strategy and the vision and leadership of SAP under Henning Kagermann.”

Agassi or Apotheker? That’s for the future. For now it’s Kagermann remaining firmly at the helm. And however much he must be enjoying the impact that the scuttlebutt about his predatory intentions is having on the market, there’s no chance of that nameplate on the CEO door being changed to Ellison anytime soon. That really would sap credibility.

Find out more about Stuart Lauchlan

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