SAP is almost the industry bellwether in enterprise application software. When SAP is struggling, it is a sign that everyone else is, and when it does well, the remainder of the industry follows. At least that is the way it appeared until 1999 when the business-to-business procurement, electronic marketplaces, supply chain management (SCM) and customer relationship management (CRM) systems vendors broke away. While those vendors were consistently returning huge growth figures, enterprise resource planning (ERP) was dying on its feet.
At the time, many commentators saw SAP on the brink of terminal decline. Its R/3 software, sold on the principles surrounding business process re-engineering (BPR), had apparently become irrelevant. As 1999 rolled on, rivals in the areas beyond its reach began taking away significant business. Siebel Systems pushed relentlessly forward in the CRM market while SAP had nothing much to say. In SCM it was being walloped by i2 after a partnership with the company fell through. Upstarts like Ariba and CommerceOne appeared, generating phenomenal market momentum around the concept of e-marketplaces. More than 200 of SAP's key executives deserted the company for richer pickings - often at the very start-up vendors that were carving up chunks of SAP's turf.
While some disagree, there is a wide consensus that co-chairman Hasso Plattner misread and misunderstood the US market and management culture. For over a year, he refused to allow management to participate in the fortunes of the company, and it cost SAP dearly. Plattner, an engineer at heart with a stubborn streak, was often cast as mercurial and became the butt of industry jokes. When interviewed, he frequently chose to argue rather than provide answers, a practice which came to a head during heated debates with the press at the highly publicized 2000 SAPPHIRE user conference in Berlin.
Plattner's co-chairman Henning Kagermann was clearly distressed that a company that had become the model of excellence in delivery, sales execution and growth had lost some of its finest talent. But SAP had recovered from slumps before, developing R/3 as the replacement for the older mainframe based R/2 product to keep the company afloat through a major industry change.
SAP's competitors would dearly like to see it killed off, but in its most recent pronouncements and analyst conference calls, it has demonstrated that it is getting back on track. Whether it completes the transition successfully remains an open question but today at least SAP is, by its own admission, a company in transition.
The company's most recent financial analyst call and earnings announcement once again failed to impress. Although the company had met its own expectations, the market wanted more. What's more, SAP's business is changing radically. It has a major revenue-sharing partnership with CommerceOne as well as transaction-based pricing and a range of options that make an assessment of its financial performance more complex (see box). As a result, SAP is having difficulty explaining its short-term numbers to analysts.
Taken at face value, SAP's third quarter results appear to mark a genuine turning point. License revenue, which had collapsed in 1999, rebounded 53 per cent to 480 million euros ($450 million). Total revenue at 1.4 billion euros ($1.3 billion) was up 26 per cent with service revenue virtually flat. SAP has admitted the service organization needs to get back on track, but it expects service revenue not to grow as quickly as licenses because the service contribution of mySAP.com is less now that the company is accelerating time to deployment.
Despite a weak third quarter, two important metrics stand out. mySAP.com contributed 294 million euros ($276 million) in revenue, sequentially up from 260 million euros. Secondly, the second and third quarter decline was a full five points less than in 1999, indicating a ramping up of revenue going forward. According to Kagermann, mySAP.com now accounts for 70 percent of total new software sales and the top five deals amount to around 100 million euros ($94 million). Although i2 still outperformed SAP with its strategic procurement deal cut with Siemens, said to be worth $142 million over three years, it is still a creditable performance. Bottom line profit, after allocating 54 million euros ($51 million) to the employee stock plan, was 88 million euros ($83 million). Liquid assets on the balance sheet stand at 1 billion euros ($940 million) and deferred revenue, another key growth indicator, stands at 554 million euros ($520 million), up 47 per cent from December 1999. 1999's fourth quarter was stupendous and during the analyst call, Kagermann was careful to stress that the market should not expect a repetition this year.
So what has happened? Plattner and Kagermann, though different as chalk and cheese, are both pragmatists. Plattner, deeply wounded by personal attacks, has demonstrated a talent rare in technology leaders - the ability to put ego aside and do the right thing for everyone involved in the company. The juggernaut has turned in dramatic fashion. Marketing, long a source of derision, has been overhauled. Advertising has relocated to New York and SAP regularly appears on national television channels worldwide with a campaign that plays directly to its strengths. The company talks about each product set clearly and has created a logical roadmap for the development of mySAP.com as distinct from the more abstract SAPMarkets. Crucially, SAP has introduced a much simpler pricing systems for mySAP.com and its e-business products.
Pricing had caused considerable confusion among customers. Kagermann insisted that mySAP.com pricing would require minimal additional cost, which SAP claimed to be "less than ten percent and usually around five percent." But rumours persisted about a requirement to re-license and a confusing system SAP called role-based pricing. Some customers were reporting additional costs of up to 20 percent of the license fees they had previously paid. Lucent, which has invested an estimated $200 million in creating a wall-to-wall R/3 system, was said to be particularly disgruntled at the price it was being asked to pay. Although Lucent denied allegations that it planned to abandon SAP in favor of Oracle, it also did not plan to implement new SAP products anytime soon, a blow from what was SAP's flagship US reference site.
SAP's product strategy has four planks. First, the R/2 system is being officially retired in 2004 after 25 years. Customers will need to migrate to R/3 and depending on the degree of complexity, they will need to make firm decisions about how this is achieved in the next year or two.
Second, R/3 continues to be enhanced at the margins and customers will continue to be supported on that platform for the foreseeable future. Migration to the Internet-based mySAP.com may require either a substantial or minimal upgrade, depending on which release they are on. Customers on release 3.11 and above have until 2003 to be retro-fitted with mySAP.com, while others will receive credit for their upgrade licenses for a limited time.
The bulk of development effort is focused on the third and fourth planks, mySAP.com and SAPMarkets, the latter falling into a separately operated subsidiary. mySAP.com, which was first announced at SAPPHIRE 1999, is positioned as being evolutionary rather than revolutionary, since it draws heavily on the R/3 heritage. But, from a customer perspective, it is a radical departure in two fundamental ways. Firstly, the screens are far more intuitive and easy to use than R/3. A continuing criticism in running R/3 was that screens were cluttered and difficult to understand and had the net effect of making the system very difficult to reconfigure once it was deployed. But with new personalization features, the browser-based mySAP.com screens provide users with what they need to do the job at hand by understanding the basic navigation concepts of the Web. From a user perspective, this change should make customers more productive in a shorter time, radically reducing training costs.
Secondly, although the R/3 system forms the heart of mySAP.com, financials has been split from HR and newer functionality like SCM, CRM and strategic enterprise management (SEM) are discrete application lines in their own right. SAPMarkets is layered on top of these four additional product lines.
SAPMarkets, a joint development effort between CommerceOne and SAP, was formed as a way for SAP to get into the indirect procurement market and has since expanded into full-blown strategic procurement under the product banner MarketSet. It has its own development organization that is based in Germany and the US. Both companies contribute to engineering but SAP controls the final code. This should mean a tight integration between mySAP.com and SAPMarket products, but the company is still in early release stage and the functional extent is limited. Indirect procurement is not rocket science, although issues around scaling mean that a significant engineering effort was needed. Strategic procurement is a different animal altogether.
SAP has a vision based on the idea of collaborative, end-to-end commerce.
But when applied to the complex, multi-tiered global enterprise, SAP is faced with integration on a grand scale, with multiple order management systems that feed to supply chain planning/forecasting and then on to supply chain execution systems not governed by traditional business practices. Such advanced systems will almost certainly require an important real-time processing capability. SAP is working on solving the problem by cranking up server performance using IBM databases and claims to be achieving performance improvements by a factor of ten over that achieved in the past. However, making fundamental database changes is not trivial.
SAP has the capability to build the complex functionality for procurement solutions but it cannot do so alone, hence the CommerceOne relationship. It has also chosen to use webMethods as its third-party data integration partner. webMethods' comprehensive set of adaptors allows relatively fast track plugging of one application to another at the data level, but it has yet to prove it can successfully scale to the kind of levels SAP is likely to encounter.
SAP's risk in this is limited because it will control the all-important business process integration that is required to ensure that all operations remain synchronized. But what is not clear is the degree of overlap between SAPMarkets and mySAP.com. At face value, SAPMarkets is playing to the fashion for creating electronic marketplaces, freeing up the organization to offer a collaborative play which positions SAP as a best-in-class vendor just like its competitors. In the longer term, the lines are likely to become blurred. Already, SAPMarkets in Europe does not have a direct salesforce but refers leads to the SAP sales teams.
Regardless of what happens, the net effect of these changes suggests that SAP no longer considers itself to be the only option to its customers. Rather, it is positioning to operate as a supplier of application components, removing the fear for customers that taking on SAP means becoming entirely beholden to one software vendor. At the same time, SAP can present discrete return on investment models that customers can compare in a competitive tender.
But what of the mid-sized enterprise? SAP's past inability to develop a pricing model that allows it to compete with mid-range specialists is being addressed through SAP's ASP (application service provision) partnering initiatives with Internet service providers such as the UK's HostLogic, iFusion.net and Origin. Today, SAP is much more realistic about what "mid-sized" means and uses the DTI model of enterprises with less than 500 employees. Costs can be in the range £200 to £300 ($300 to $450) per month for a basic system. Functionality is limited but customers can customize the product offerings as the business changes.
SAP's approach to the ASP world is refreshing. From a mid-range vendor perspective, it represents a significant potential threat. In the past, large enterprises frequently had SAP R/3 at the center and then chose another vendor around the periphery because smaller businesses could not cope with R/3's complexity. Today, that distinction has evaporated, and in a world where collaboration, both internal and external, translates into competitive advantage, SAP's ASP model stands a good chance of success.
Changing the culture and in turn the business practices of a company the size of SAP is tough for any management. But it is a highly professional organization, with some of the most experienced management anywhere in the world. It also has the advantage of having experienced radical transition in the past and has demonstrated an extraordinary ability to change. The impression today is of a company that is willing to listen and respond to criticism. Its products remain world class and the numbers are starting to reflect the work it has put in. Now it needs to build momentum and that can only come from a customer base that ultimately feels it is achieving real value.