SAP: Financials Are Rosy, But Trouble Is Brewing in the Ecosystem

For a company that generates a dearth of media attention outside of tech circles, SAP has generated a fast and furious string of exploits as of late.

There’s been no shortage of intrigue: corporate scandal and embarrassing lawsuits (courtesy of Oracle and Waste Management), outrage from SAP’s own customer base (sparked from maintenance fee increases), failings in new business models (see TomorrowNow debacle and Business ByDesign troubles), drastic need for SAP skillsets in the ecosystem (related to classic supply and demand talent shortages) and the near constant marketing wars with No. 1 competitor Oracle.

That’s all been the bad news. And it’s significant.

The good news to SAP executives and shareholders has been SAP’s recent financial success. On July 29, the German software giant reported solid second-quarter financial results and brightened its overall outlook for 2008. That sent its shares up more than 6 percent that day, despite the fact that SAP reported a net profit of $641.6 million for the second quarter, which was down 9 percent from the same time in 2007.

No matter, said top SAP execs: Business remains strong.

But that quarterly financial snapshot is far too short-sighted to serve as an accurate assessment of SAP’s overall health. When taken together, all of the aforementioned and seemingly disconnected problems point to looming, significant challenges on the horizon, adding up to more uncertainty than I’m sure SAP executives are willing to let on in those canned conference calls.

Business ByDesign, for example, was supposed to show that SAP understood customers’ desire for software-as-a-service products and that it could offer both on-premise and on-demand ERP applications to small, midsize and large enterprises. So far, “the product has been set back by a variety of issues resulting in reduced ramp-up projections and funding,” notes Forrester Research analyst Paul Hamerman in a recent report. SAP execs have told Hamerman that the Business ByDesign product has yet to be “operationalized in a profitable manner.”

In the meantime, while SAP works out its “mega-tenancy” issues with Business ByDesign, competitive threats are coming from NetSuite, Workday and Fujitsu Glovia Services, which are looking for a piece of the emerging SaaS ERP opportunity, notes Hamerman in the report. SAP Co-CEO Henning Kagermann said during the quarterly conference call in July that a strong deal pipeline was one reason for SAP’s confidence. That pipeline could dry up, however, if those competitors nipping at SAP’s heels continue to tap into key pieces of its disheartened customer base.

The next problem: SAP’s operating margins are still lower than Oracle’s and even Microsoft’s. In announcing its second-quarter results, SAP forecasted margins of around 29 percent for the full year. Oracle made a 36 percent margin last quarter, and Microsoft, which is becoming more of an enterprise player with each passing quarter, took home a 31 percent operating margin, according to a CNBC.com article.

Of course, many enterprise software vendors’ operating margins are buoyed by maintenance fees, and SAP is no exception. “Maintenance is the most profitable part of the business,” Ray Wang, a principal analyst at Forrester Research, has told me several times in the past.

In July, SAP announced that is would be moving all customers to its new Enterprise Support maintenance plan in early 2009, which offered new support options as well as an increase in price—from 17 percent of contract value to 22 percent.

SAP user groups, such as the U.K. and Ireland SAP User Group, were none too pleased. “The mandatory nature of this change along with the increase in cost has received hugely negative feedback from our membership to date,” noted the group’s chairman. SAP execs have been preaching the new value of the maintenance offer, but many of its most loyal customers aren’t buying it. The blogosphere has taken SAP to task for jacking up “maintenance rates without spending the time and energy to make a case for an increase in value commensurate with the new 22 percent rate.”

In turn, SAP’s own customers have started looking, with more interest, at third-party maintenance and support providers, like Rimini Street.

Throw on top of that a debilitating lack of SAP skillsets in the SAP ecosystem and the embarrassing and costly lawsuit by Oracle over SAP’s TomorrowNow subsidiary, which is now on its deathbed, and SAP CEO-in-waiting Leo Apotheker has much to contend with when he eventually takes over the sole CEO reigns.

Look, no one’s arguing with the merits of SAP’s code or range of application sets. When I talk to SAP users and CIOs, what they mostly harangue about is the complexity of installing the software and the herculean change-management efforts that are absolutely necessary, a complexity that SAP’s own executives concede is real inside their customers’ IT environments.

As I have said before, there are only so many enterprise customers, like Wal-Mart and Coca-Cola, that SAP can sell to. At some point, the delays in penetrating the SMB market combined with all of the other self-inflicted distractions and missteps will eventually catch up with SAP—maybe not today or tomorrow, but sooner rather than later.

And as we all know, when dissatisfaction with any product grows and grows, and when something new and better comes along, as is happening today with SaaS, cloud computing and Google apps, then customers will have no qualms ditching the past for something that is future ready.