SAP Caught Between Two Worlds

Posted by: Steve Hamm on May 8, 2007

SAP’s going to have a hard time hopping on the software-as-service bandwagon without blowing up its $12.4 billion traditional software business in the process. That message came clear to me today when SAP board chairman Hasso Plattner give a keynote speech at the Software 2007 conference in Santa Clara, Calif., and talked to reporters afterwards.

SAP CEO Henning Kagermann announced a few months ago that the company will later this year deliver its most important new software product in a long while. The software, code-named A1S, is an entire new suite of run-the-business applications delivered over the Internet as an on-demand service. From Plattner's speech, it was clear that the new software is a big deal for SAP. He said the company has been building it in stealth mode for three years, and 3,000 programmers are working on it now. "It's a viable alternative to on-site computing," he told an audience of about 2000 people.

But the company is sending mixed signals about how big the market opportunity for the software is and how capable it will be. SAP describes its target as the lower end of the middle-size corporate market--which doesn't sound like a very big business. And Plattner seemed to blow hot and cold on the product in the meeting with reporters after his keynote. At one point he said most sizable corporations wouldn't find this package compelling. Yet, in answer to other questions, he said the new package will allow for lots of customization and will have 2,500 application programming interfaces that software engineers can use to write extensions to the basic functions. Also, the software is designed to that other applications within companies can easily be integrated with it. That makes it sound like it's mighty capable indeed, and even some large corporations might find it compelling.

What's going on here is that SAP has to market its new product without cannabalizing its old cash-cow products. That's going to be very difficult. It's clear from the stellar performance of Salesforce.com that on-demand services have struck a chord with corporations of all sizes. And now Dave Duffield, founder of PeopleSoft, has a new company called Workday that's about to release a whole range of run-the-business applications in the on-demand mode. So SAP has to be in the game. Yet most all of its revenues and profits now come from old fashioned software.

Bruce Cleveland, a venture capitalist who used to run the on-demand division for Siebel Systems, now part of Oracle, did a good job of summing up SAP's challenges in a response to an e-mail from me today: "As long as they're a public company, I don't believe they can make this transformation. It's absolutely the right strategy, but the internal DNA of the company will defy their ability to support both business models." Cleveland should know. That's partly what led to Siebel's collapse, which forced it to sell out to Oracle.

SAP has successfully made several transitions before--from mainframe software, to client-server, and then to Web-based software. This move promises to be more challenging, though. And Plattner, who engineered the earlier migrations, is no longer running the company. Already, one of SAP's top technologists, Shai Agassi, has quit due partly to conflicts with Kagermann over the strategy. Who knows what tribulations are yet to come?

Reader Comments

Ken Rudin

May 9, 2007 2:39 AM

Hi Steve --

SAP is by no means alone in facing this challenge; all enterprise software companies are wrestling with the same issues. I have experienced both sides of the equation -- the pure-play on-demand vendor side (I was one of the earliest employees at salesforce.com and ran the products team there), and the traditional enterprise software side (I started up and ran the Siebel CRM OnDemand division within Siebel before Bruce Cleveland). From my experiences, I can state confidently that while it may not be completely impossible for enterprise companies to make the switch, it is about as close to being impossible as you can imagine, particularly if the company is public. Every division within an enterprise company resists the change to on-demand: sales, marketing, finance, etc. Some day I'd love to write a book about the stark differences between what I experienced at salesforce.com and what I experienced at Siebel.

I even see the same cannibalization challenges being faced in the Business Intelligence industry. My current company (LucidEra) focuses on delivering Business Intelligence as an On-Demand solution. The incumbents like Business Objects are trying to deliver an on-demand solution, but have only taken timid first steps, and inside sources will tell you that just that little bit is causing great internal conflict at that company. The real threat of cannibalization is creating an internal civil war.

Thanks -- Ken Rudin, CEO, LucidEra

Bruce Cleveland

May 9, 2007 5:43 PM

Steve:

A follow-on comment. You note that Hasso has led SAP through several successful transitions: mainframe to client server to web-based.

Those were technology transformations - difficult feats to be sure and he is to be commended for his leadership.

Today, however, the transition SAP is facing includes a business model transformation as well as a technology transformation.

This is the Innovator's Dilemma squared.

In my humble opinion, this will deal a double body blow that can not be withstood.

Bruce Cleveland
Partner
InterWest Partners

Bhoovarahan Thirumalai

May 10, 2007 1:05 PM

Hi Steve and Ken:

To a large extent, this is similar to what happened when ecommerce went head-on with traditional brick and mortar firms - and as old as David vs Goliath scenario.

Amazon sets up shop online and takes major marketshare from Barnes and they try to catch up, but what is lost is, in many instances, lost!

Does not mean that Barnes or Borders have shut shop! Does not mean that they will not come with strategies to survive and in many instances fight back and win!

In the same conference, Steve Ballmer was talking about Microsoft's "staying power" and perseverance, and with that in place, I am sure it is possible even when they are public.

Ken Rudin

May 12, 2007 12:34 PM

Bhoovarahan --

I am not predicting the downfall of SAP. Rather I'm saying that they are very unlikely to be successful in the on-demand market. That means that they will most likely lose important market share, as much of their current market will be attracted to the on-demand model. They may even figure out how to fight back, but by the time they figure it out, the competitive landscape will have changed dramatically.

Thanks -- Ken Rudin, CEO, LucidEra

JC

May 15, 2007 5:36 PM

Oracle Fusion? What Fusion?

Michael Wm. Denis

May 17, 2007 1:58 PM

SAP's Challenge is Corporate DNA

I can not speak for all industries that SAP competes in, but I can speak for the Airline, Aerospace & Defense industry which I have spent the past 20 years working in. SAP's challenges are their corporate DNA - leadership / governance, business model and technology. In the long run and without radical changes, SAP may have seen their best days in the rear view mirror.

I would have to agree with Bruce Cleveland and Patrick Walravens, JMP Securities, SAP's business performance and technology are in disarray because of the changing business models (like SaaS) which is due to leadership and governance issues. Agassi's departure is just a public demonstration of the internal debate and lack of commitment to a clear strategy and execution moving forward.

Five years ago, SAP made the short list and most often final selection list for most of my customers. Two years ago they would usually make the short list. Today, they are one of the first names crossed off the long list. In the AA&D industry, some of this is due to very well known disasters at several very large airlines and defense organizations. But it is also due to the disconnect between strategy and execution.

The trends in the IT industry are well known - standards consolidation, vendor consolidation, open source acceleration and subscription / utility computing acceleration - leading to commoditization and Red Ocean hyper competition. Less well known are the trends in the Airline, Aerospace & Defense "Sustainment" or MRO industry (Maintenance, Repair & Overhaul = after product sales services). Twenty years ago, every airline did every activity in house, from reservations & call centers to catering to MRO/SCM and they had the cost profile to prove it. It doesn't take a rocket scientist to figure out that if you do an activity in-house you have a customer base of one, if you are good at it then the in-house capability can and should become a profit center by selling the service to others - or - if you are bad at it, you outsource it to others. So operators of aircraft have been transitioning, as fast as their unionized labor groups or bankruptcy judges will allow them, to a shared services business model.

In fact, the first industry to embrace an ASP model was the airline industry back in the '70s - via Computer Reservation Systems (CRS = Sabre, Worldspan, Amedeus, Navitaire and Galileo) all of which originated at one airline who sold the service to others. The CRS's expanded there capabilities and became Global Distribution Systems (CRS/GDS) and the central nervous system of airlines. Delta even calls their core IT, the Delta Nervous System (DNS).

This same trend has occurred in the aviation MRO sub-industry, over the past ten years and rapidly accelerating over the post 9/11 time frame. Most airlines outsource the majority of their maintenance and a few large companies (some airline based Lufthansa Technic, Delta TechOps, KLM/Air France Industries, Air Canada Technical Services, Singapore Engineering, Air New Zealand Engineering Services - some independent ST Aero, Dubai Aerospace Enterprises, HAECO, TIMCO, and all of the engine OEMs (Rolls, GEAE, Pratt, IAE and CFM). This disaggregation of multiple sources of service increased the complexity of business synchronization, regulatory compliance and data syntax / information integration and collaboration. So the AA&D industry took a page out of the automobile industry (Ford, GM, Chrysler give their tier two & three suppliers IT for free in order to optimize assembly plant operations) and what the CRS/GDSs did in the ‘80s - and began bundling IT with other services - logistics, maintenance, documentation, etc... The cost of giving away software doesn't come close to the cost of labor, materials or cycle time (FYI - the aviation business is ROA driven - borrow a lot of money to lease expensive assets and infrastructure, then hire a lot of labor and hope to make a profit if you can utilize the revenue generating assets at a high rate – which means, assets that are out of service for maintenance are also out of revenue generating availability).

GE bundles On-Point and Rolls Royce bundles DS&S with their Power by the Hour maintenance contracts. LHT gives away a J2EE MRO IT solution called manage / m to their customers bundled into maintenance, logistics or asset management contracts. Lockheed is bundling the Autonomic Logistics Information System (ALIS) with the Joint Strike Fighter under a Performance Based Logistics (PBL) contract which the USAF, USN, USMC, RAF, RAAF and eight other nations are buying. Boeing offers the Goldcare “utilization based pricing model / bundled services” to all of their 777 and 787 customers, which includes an option for MRO and SCM IT.

This is not pure SaaS - more like BPO + IT - but two fundamental points are pertinent to the broader SaaS and open source IT markets. One, the enabling technology is web native (mainly J2EE and some .NET) with more and more open source (MySQL, JBoss, Linux, PHP, Apache, ...) and with the required multi-tenant architecture. Two, the IT vendors that are surviving recognized the changing business model and industry trends and changed their own business models accordingly - mainly aligning themselves with a strategic channel partners – one of the OEMs, one of the large MROs or one of the CRS/GDS services vendors. These few, privately held software and services firms moved to the Blue Ocean where they don’t have to compete on functionality, technology or price (although they have robust offerings well below the average ERP vendor) and everyone else is going out of business or getting out of the industry.

So, as I asked Bruce Richardson, AMR, prior to the anti-climatic Sapphire 2007 (in my home town of Atlanta this year), how is SAP going to compete in an industry where software is sold as an element of a bundled service or is free? Not to single SAP out, the same question could be posed to Oracle CMRO, IFS, Lawson and a host of others.

The question that I probably should have posed is, "If SAP is getting back to their roots as an application company, why would they want to invest and compete in an industry where software is free?"

So back to SAP's DNA challenge.

NetWeaver was marketed as SAP's answer for composite application enablement. MDM also solved one of SAP's fundamental technological challenges, data referential integrity. I will give SAP business kudos for designing a fundamental deficiency in their structured language ABAP modules and then getting customers to pay to bolt on a solution that fixes the problem they created. With respect to selling the NetWeaver "strategy", no one told the sales force - or more importantly, changed the compensation model. So even as SAP was pitching NetWeaver as a platform for EAI and BPM which could leverage both legacy and web native applications, the sales force was doing what they were being paid to do - "sell SAP does all." Part of SAP's leadership / governance DNA is decisions by committee which does not lend itself to redirection well.

Larry Ellison, on the other hand, is a decisive, focused and visionary leader. Admire him or loathe him, he sees trends and makes decisive moves. Ellison is redirecting Oracle by embracing On-Demand, yet he understands the difficulty of changing the course of the Titanic and the cannibalistic nature of the on-premise business model versus SaaS and utility computing / infrastructure business models. So at the same time he is changing Oracle Corporation, Ellison is "hedging his bets" and getting to market faster via personal investments in NetSuite, Salesforce.com and open source companies like InnodB and SleepyCat. Something should also be said for the IT company CEO factory that Oracle has become – industry specific similarity to GE (more CEOs of Fortune 1000 companies are ex-GE executives). Given Oracle's acquisition per month consolidation strategy (latest being Agile PLM), I'm pretty sure Oracle will gobble up Ellison's personal hedges at some point in the future.

The significant point here is, Oracle has Ellison as captain of a fleet of ships, each of which has different business models across the entire eco-system. Business strategy, executive compensation, marketing, sales, sales force compensation, product strategy, operations, delivery and services can be aligned by avoiding the dyslexia of attempting to be all things to all people under the same roof – which is SAP’s DNA challenge.

Respectfully,

Michael Wm. Denis
Partner / CTO
BWSI

PC

May 24, 2007 12:38 AM

don't know if this has been previously mentioned in previous postings (some where a bit lengthy), but I see the primary issue in switching from traditional enterprise software to SaaS is not so much the license revenue but more importantly the ongoing support revenue stream.

In Oracle's case it is a huge annual annuity from existing customers, in SAP's case it comes in the form of a complete repurchase of the existing licenses as part of the upgrade process.

SaaS revenue realized from a customer can equal and in some cases surpase traditional enterprise software revenue over a four year period, but the support revenue would completley disappear. It would be impossible for a publicly traded company to survive this massive hit to the bottom line should SaaS be broadly adopted.

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Bloomberg Businessweek writers Peter Burrows, Cliff Edwards, Olga Kharif, Aaron Ricadela, and Douglas MacMillan, dig behind the headlines to analyze what’s really happening throughout the world of technology. Tech Beat covers everything from tech bellwethers like Apple, Google, and Intel and emerging new leaders such as Facebook to new technologies, trends, and controversies.

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