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SAP: A Sea Change In Software


These are heady days for software giant SAP (SAP). The 33-year-old company, based thousands of miles from Silicon Valley in tiny Walldorf, Germany, set the gold standard in the 1990s for software that companies use to manage their businesses. Some 27,000 of the world's largest organizations now automate everything from accounting and manufacturing to customer and supplier relations using SAP software. That makes it far and away the leading seller of big corporate programs, with record revenues last year of $9.5 billion, up 7%, and profits of more than $1.6 billion. Analysts predict revenues will climb 11% this year, and SAP shares are near their 52-week highs.

SAP's story sounds rosy except for a nagging problem. Its fiendishly complex and notoriously inflexible programs worked fine for 20th century companies. But as a growing number of SAP's customers embrace a faster, more agile business model, they need software that's simpler and easier to modify. Faced with globalization, outsourcing, changing regulations, and rapid technology shifts, they can't afford to wait for an army of German programmers to release a new software update every few years. "Ten years ago, software customers wanted stability and reliability, and we gave them that," says SAP Chief Executive Henning Kagermann, 57. "Now they want competitive advantage, differentiation, and most of all, speed."

Thanks to a dynamic young exec named Shai Agassi, SAP has an answer for that. Ever since SAP acquired Agassi's San Jose (Calif.) startup, TopTier Software, in 2001, the 36-year-old Israeli has led a campaign inside the company to open up SAP's closed software and make it easier for customers to tweak applications to suit their needs. With Kagermann's strong backing, Agassi began delivering bits of more flexible software in 2003. Now the scale of Agassi's makeover is becoming clear. Over the next few years, SAP will launch completely revamped products that will be far more malleable than anything the company has offered before.

The move thrusts SAP squarely into the most important -- and hotly contested -- trend to hit software in a decade. Known as Web services, the new approach uses messages sent over the Net to link up pieces of software running on different computers. Everyone from Microsoft Corp. (MSFT) and IBM (IBM) to SAP and Oracle Corp. (ORCL) is jumping on Web services because the technology lets customers more easily share information and coordinate work, even linking older systems into state-of-the-art software. "This is going to change the efficiency and productivity of software forever," says Josh Greenbaum, principal of Enterprise Applications Consulting Inc. in Berkeley, Calif., which advises info-tech vendors and customers.

The migration carries big risks for SAP, though. The software company has already committed an estimated 2,200 software developers and $1 billion in research and development spending to its new technology, which is dubbed NetWeaver. But competitors are developing their own rival programs. SAP's technology won't be fully rolled out until 2007. "SAP has certainly laid out an interesting vision," says Charles Fitzgerald, general manager of platform strategy for Microsoft. "It will be interesting to see how well they deliver on it."

ENGINEERING EDGE

The first pieces of NetWeaver in 2003 were tools to bridge the gap between SAP and non-SAP software. Now SAP has gone much further. It's breaking up its software into smaller chunks that customers can snap together or break apart like Legos. They're tied together with open Web services. The advantage: Customers can pick and choose just the features they need, and even add in chunks provided by companies other than SAP. That will let them create and modify applications faster and more cheaply than they can today.

There's also an engineering benefit to SAP. Its own programmers will now be able to develop software in bite-size pieces, speeding delivery of new functions. Instead of waiting years between humongous software releases, there can be what the company calls a constant "conveyor belt" of improvements. "This is a game-changer," says Agassi, who joined the SAP executive board in 2002 and was named chief of product development in May.

Industry response to NetWeaver is encouraging. At an SAP convention in May, leading lights of info tech such as Intel (INTC), Cisco Systems (CSCO), EMC (EMC), and Adobe (ADBE) pledged to develop products that can work with the software. "SAP is setting the standard that other application vendors will inevitably have to follow," says Nick Earle, Cisco's vice-president for Europe, Middle East, and Africa. At the same time more than 1,300 SAP customers, including Colgate-Palmolive (CL), Aventis, and Whirlpool (WHR), are far enough along with NetWeaver that they're willing to serve as references for potential buyers.

NetWeaver so far hasn't contributed to SAP's revenues. Most of it is now bundled for free into other SAP software. But if NetWeaver catches on, SAP has an opportunity to gain enormous power and influence. Like Microsoft Windows on desktop PCs and servers, NetWeaver could define an industry standard for creating new business applications. Thousands of independent developers could start writing specialized programs that plug into the NetWeaver framework. That would give SAP entrée to millions of new customers whose businesses were too small or needs too esoteric to use SAP's older, one-size- fits-all packages, which could cost hundreds of millions of dollars and also take years to install.

To build a new ecosystem around NetWeaver, SAP is turning on the charm. Six months ago it hired George Paolini, the executive who marketed the wildly popular Java programming language for Sun Microsystems Inc. (SUNW), to lure outside developers. Some 132,000 have already signed up for an online network that provides information and technical help. SAP also has managed to attract more than 200 top managers from Oracle, BEA Systems (BEAS), and Siebel Systems (SEBL) in the past 18 months.

Still, many questions remain about NetWeaver. For one, SAP hasn't yet disclosed pricing for the modular version of its software. The danger is that customers could buy less software from SAP or use more products from other vendors. Kagermann doesn't seem worried. By helping SAP customers "become more flexible and competitive," NetWeaver will help keep them in the SAP fold, he says.

Then there's the competitive threat. Both Microsoft and IBM do far more business in partnership with SAP than in competition. But each has its own approach to Web services that differs from SAP's. Over time, that could become a source of friction. "They're trying to build a world where everything is built around SAP applications. I just don't think it's going to work," says Mark Hanny, vice-president for alliances at IBM Software Group. "It's a heterogeneous world. This is very limiting."

TRENCH WARFARE

Oracle is a more direct worry. It has announced a project called Fusion that will unite its own software with the disparate product lines it acquired last year from California-based PeopleSoft, a major provider of business applications, and then link up the pieces with Web services. Oracle executives say their approach will be more open than NetWeaver. "SAP's products are built using proprietary language that is decades old," says Oracle CEO Lawrence J. Ellison. "Fusion applications are built entirely on industry standards." The PeopleSoft merger is already paying off: On June 29, Oracle said combined application license sales grew 52% in the fourth quarter. Still, SAP has a healthy head start. The first parts of Oracle's ambitious revamp are promised for 2008, a whole year after SAP's project is set to be finished.

Long before either company completes its makeover, each is fighting trench warfare to grab customers today. In January, SAP began offering Oracle customers credits worth up to 75% of the value of their software if they switch to SAP. It claims that 10 have done so since the PeopleSoft acquisition, including Samsonite, which announced its move on June 21. Oracle recently announced a retaliatory offer giving SAP customers 100% credit on their old software if they chang to Oracle. It claims to have nabbed a half-dozen SAP customers in recent months. Still, Goldman Sachs projects SAP's market share among the top four corporate applications sellers will climb from 62% at the end of 2004 to 72% this year, while Oracle's falls from 28% to 19%.

SAP users are starting to tell stories about NetWeaver that lend credibility to the company's strategy. London-based Rexam PLC (REXMY), the world's leading aluminum can producer and No. 5 in packaging overall, is using NetWeaver to radically overhaul its manufacturing. Rexam used to keep on hand a hoard of 5-ton aluminum coils used for making cans. Now, by using SAP's software to link suppliers directly into its manufacturing, Rexam has suppliers keep track of its inventory via the Net and automatically send replacements as coils are used up. That has let Rexam cut on-hand supply of its most expensive component by half. What's more, says Chief Information Officer Paul Martin, "suppliers like it, too, because it helps them manage their own businesses better."

Users such as Rexam could go even further now that SAP is releasing more pieces of NetWeaver. In May, the company published a catalog of 500 SAP software objects, each of which performs a defined business process such as the book-to-bill sequence. Customers or consultants can use these objects to build new software applications.

The success of SAP's long-term vision lies in attracting an army of independent software developers to support NetWeaver. Some 150 third-party programs that have been built for NetWeaver are already available, Paolini says, and analysts figure that the number could top 500 by 2006. That should help SAP burrow into potentially thousands of niche markets that are too small to pursue on its own. Modular software also could help SAP dive deeper into small- and midsize businesses, the fastest-growing segment of the market, where it faces growing competition from giant Microsoft.

A decade ago, SAP improved the way businesses operate. Now the company wants to change the entire software industry. "We could have sat back and waited for the storm to pass, but it never will," says Agassi. "Instead, we decided to lead it." Ambitious, yes, but in high tech nobody ever got ahead by holding back.

By Andy Reinhardt in Walldorf, Germany


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