Technology

Upping the Ante at SAP


What does a company do for an encore when it dominates its core market, grows at twice the speed of its industry, and sees its stock price rise 40% in the past 12 months? If you're SAP (SAP) of Germany, you double down your wager.

On May 9, SAP is announcing that it will pay 300 million euros ($381 million, at current exchange rates) to several hundred managers and key employees if they can double the market capitalization -- with a $57 billion starting point -- by the end of 2010. A third of that would go to the top seven executives.

BOLD MOVE. The bonus plan, announced at the annual shareholder meeting in Mannheim, Germany, is way out of character for SAP, which has a reputation for being very well managed, but predictable and cautious. And while performance-based bonuses for executives are common, SAP's new compensation program is unusual both for its size and scope.

The plan was dreamed up by Hasso Plattner, a hard-charging SAP co-founder, who has been nonexecutive chairman of the supervisory board since he stepped down as co-chief executive three years ago. Plattner sees the bonus as a way to inject entrepreneurial vim into a 34-year-old company with 35,000 employees and a vast array of products. "If you have outrageous goals, then probably you can achieve outrageous things," he says. SAP is the market leader in software applications for accounting, human resources, customer management, procurement, and manufacturing.

When it comes to richly compensating top executives, Germany doesn't hold a candle to the United States. Total compensation for Oracle CEO Larry Ellison was $11 million last year, compared with $7.5 million for SAP CEO Henning Kagermann. So SAP expects to hear criticism from corporate watchdogs on its home turf. But Plattner argues that the bonus payout, as generous as it is, would only be fair compensation for what would be an impressive feat. SAP is already highly valued by investors, with a price-to-earnings ratio of 38. That compares with 24 for Oracle (ORCL) and 16 for IBM (IBM), the two largest players in the overall corporate software sphere.

WITHIN REACH. In fact, SAP's stretch goal isn't all that farfetched, according to analysts. The company, which had $10.5 billion in sales last year, grew its core software license revenues -- a key indicator of future revenue prospects -- by 22% in the first quarter. Analysts figure that if it can grow software license revenues by an average of 15% over the next four years, it will be able to more than double its earnings.

The company delivered 5 euros in earnings per share last year, and analyst John Segrich of JP Morgan forecasts that it can achieve 13 euros in 2010. Segrich believes the new generation of software that SAP plans to release next year will reach its peak demand three years later. "You will see an acceleration of their top line and margin expansion," he predicts.

SAP's top executives welcome the chance to prove they can accelerate growth yet again. "For me the important impact is that the entire company understands we're on a journey to something special, and it's achievable," says Kagermann. "People want to be in a good company and they want to have dreams."

To win the big prize, though, Kagermann and his staff will have to execute flawlessly in product development and sales. "The thing that can stop SAP is SAP. If they miss a quarter or some of their technology breaks, that would deflate the stock," says analyst Bruce Richardson of AMR Research. In addition, they'll have to overcome challenges from Oracle, Microsoft (MSFT), and pesky up-and-comers such as on-demand software leader Salesforce.com (CRM).

TOUGH COMPETITION. Oracle, in particular, is not to be taken lightly. As a result of a $20 billion acquisition binge of companies including PeopleSoft and Siebel Systems, it increased its market share in enterprise applications from 5.2% in 2004 to 12.2% share now, according to AMR. Meanwhile, SAP gained share organically -- climbing from 19.5% to 20.8%. Oracle is strong in the minds of corporate tech buyers, thanks to its No. 1 position in database software and has been coming on strong in so-called middleware, the software that knits various programs together.

Oracle seems to relish the come-from-behind role. It just published a new attack ad claiming that its application license growth, excluding the effects of acquisitions, increased 29% last quarter, and SAP's revenues for comparable products only grew 3%. It says SAP's count includes revenues from software made by others that it packages with its products, including Oracle's database. (SAP denies the claim, and analysts agree.) "We're going to wear them down," predicts Charles Phillips, a co-president at Oracle.

So far, though, Oracle seems to be getting the worst of the fight. One factor in SAP's favor over the past two years has been the uncertainty that Oracle has created among customers with its acquisitions (see BW Online, 9/12/05, "Now, Oracle May Finally Rest"). SAP claims to have landed 240 former Oracle and PeopleSoft customers, including the likes of Amgen, Waste Management, and Samsonite. (Oracle claims the defection rate has been low; here again, analysts side with SAP).

When sports-equipment maker Easton Bell Sports Group decided late last year to standardize on one software maker, SAP got the nod over Oracle, even though it already had some Oracle and PeopleSoft products installed. "Oracle has been growing by acquisition. It will take a while before it's integrated," says Sharon Nelson, Easton Bell's chief information officer. "SAP has grown organically. That made it the safe choice."

But SAP isn't counting solely on fallout from Oracle's acquisitions -- or basic growth in demand for its products -- to drive a new wave of revenue expansion. It has launched a handful of ambitious initiatives in an attempt to broaden its addressable market from $30 billion to $70 billion and its roster of customers from 32,000 to 100,000.

WEB SERVICES. The biggest piece of the plan is creating updated versions of all of its applications based on the latest so-called Web services technology. SAP's new versions will break the applications into smaller chunks that customers can snap together or break apart like Legos. Customers can pick and choose just the features they need and even add chunks they write themselves or that come from other software makers. This is supposed to let them create and modify applications faster and more cheaply than they can today (see BW, 07/11/05, "SAP: A Sea Change In Software"). Some of this capability is already available thanks to SAP's NetWeaver application integration product, but more is coming next year.

This new technology direction pleases customers such as Day & Zimmerman, a Philadelphia-based provider of construction and security services. Chief Information Officer Anthony Bosco says NetWeaver allows him to draw on capabilities from different applications and present them in an easy-to-use fashion to employees, business partners, and even customers through Web portals. "We have a variety of businesses that are always changing. We need a system that can fit them all," says Bosco.

Most of the major software makers are following a similar technology path, but SAP got off to a fast start. Analysts believe its new applications will hit the market between one and three years ahead of Oracle. That's because Oracle has taken on the daunting task of modernizing its software and weaving together applications it picked up through acquisitions in one fell swoop (see BW Online, 1/20/06, "Is Oracle's Fusion Coming Together?").

Oracle believes customers will wait for its update, which it expects in 2008 or 2009, rather than switching, but analysts expect it to suffer more defections. "SAP is in a much better position," says analyst John Rizzuto of Lazard Capital Markets. "It's the technology leader. While Oracle pauses to integrate, SAP is moving out ahead." (see BW Online, 3/21/06, "A Chill in Oracle's Hot Numbers").

MIDMARKET PUSH.A second major push for SAP is a strategy for winning smaller customers. Many current customers are large enterprises, but it now has two product suites aimed at companies with fewer than 1,000 employees and less than $1.5 billion in annual revenue. Thanks to aggressive investments in building distribution channels, those businesses now make up one-third of SAP's North American sales. William McDermott, head of operations on this side of the Atlantic, expects it to increase to 40% in the next couple of years.

Later this year, the company plans on launching the Web services versions of its products aimed at mid-market companies (see BW Online, 2/02/06, "SAP Gets On-Demand Religion"). That update -- and the marketing push around it -- will be crucial.

"They're still feeling their way in the mid-market," says analyst Marc Geall of Citigroup. The company has to build up its distribution channels and deliver products that are easier to install and use. Still, Geall says, "I think they can make their goal of having 100,000 customers by 2010."

DUET DEBUT. Another SAP initiative is more of a wild card. In June, it plans on releasing a new set of products, called Duet, co-developed with Microsoft. Duet applications combine the capabilities of SAP's run-the-business applications with those of Microsoft Office. For SAP, there's the potential of dramatically expanding the company's reach within giant corporations that are already using its products.

Does it all add up to SAP being able to double its market capitalization? That's no slam dunk, obviously. But, under Kagermann's leadership -- and with a vigorous push in the back from Plattner -- this is one mature corporate-software maker whose future has the potential to be even brighter than its past.


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