Is SAP Stumbling? Perhaps.

Event Summary

In April, the business applications market leader SAP reported a 43% drop in net income for its first quarter ended March 31, despite a 10% increase in revenue. Net income for the quarter reached $53 million, or 53 cents per share, as compared to $98 million and 92 cents, respectively, in the corresponding quarter of last year (See Figure 1). Revenue rose to $1.18 billion, from $1.08 billion a year ago. Overall, software license revenue increased by only 4% during the quarter, while maintenance revenue rose by 43% as compared to the same quarter a year ago. Consulting and training revenue, meanwhile, dropped by 3% and 14%, respectively.

Figure 1

"SAP was prepared for a challenging first quarter - and we got it," Henning Kagermann, co-chairman and chief executive officer of the Walldorf, Germany-based software vendor, said in a statement. Investors, however, seemed pleased that recent rumors about a possible first-quarter loss proved wrong.

"In response to increasing competition in the Web-based software market, particularly in the United States, SAP will continue to invest considerable resources to strengthen its mySAP.com offering", Kagermann said. mySAP.com made up $80 million, or 22 percent, of total software license sales in the first quarter, up from 16 percent in last year's fourth quarter, SAP said.

On a regional basis, first-quarter revenue in the Europe, Middle East, and Africa regions increased 15 percent to $608 million, while revenue in the Americas region fell 3 percent to $436 million, the company said. In the Asia-Pacific region, meanwhile, revenue rose 40 percent to $139 million. "Looking forward, SAP expects software sales to pick up speed in this year's second half", Kagermann said in the statement.

In a separate announcement, SAP said that Kevin McKay, head of SAP's US operations, has resigned for personal reasons. SAP tried to keep McKay in place, offering him the group chief finance officer job, but he declined. The company said: "We are sorry to see him leave, he has contributed much to SAP. We wish him well."

Market Impact

We would not brand SAP's results as dramatic if it were not for the underlying reasons that may mire its long-term prospects. The fact remains that the results were better than expected, SAP remains profitable, and it is unrealistic to expect the spectacular growth of past years for the company of that size.

However, it is worthwhile analyzing the reasons that SAP cited for its poor showing.

First, the cost of the Star share option program, which had been previously anticipated. Fine, we will go along with this one.

Second, chief executive Henning Kagermann said competition for web-based products, particularly in the US, had been fierce. The truth is that SAP has only recently begun to feel and be hurt by serious competition. Its core ERP product R/3, while still functionally superior, is not sufficient any more for sustained corporate financial success. SAP is stumbling, particularly in the United States, where competition from more nimble point solutions vendors like i2 Technologies, in the supply chain management (SCM) market, and Siebel Systems in the customer relationship management (CRM) market is taking its toll. It is also feeling additional pressure from direct competitors Oracle and PeopleSoft, who have been touting their extended ERP products that are allegedly integrated with their core ERP systems.

SAP America has also experienced a massive exodus of key personnel. It lost more then 300 staff members in the past year, including top executives, to companies like Siebel and Oracle, primarily due to its tardiness in granting stock options. McKay's departure is also a significant loss, as he guided the American operations during a particularly difficult period. We believe that his successor, Wolfgang Kemma, until recently managing director of SAP's German subsidiary, is only a temporary solution until a better-attuned CEO for the American market is found.

While SAP has so far failed in its attempt to transition quickly to new CRM and e-commerce technologies, it has recently been making moves in the right direction to remain competitive in the new economy. We endorse SAP's recent willingness to partner with other vendors for software components it cannot develop efficiently in-house. However, this is a notable departure from its previous strategy and will require a significant mindset change.

SAP should also carefully reevaluate its mySAP.com product migration strategy from current R/3 instances, in order not to alienate and disillusion its loyal customer base. mySAP.com has allegedly met resistance because SAP's licensing model requires that existing customers re-license its R/3 software. Some customers may see this as only another hefty investment with little added value other than improving a previously drab user interface. SAP competitors are only begging for a surge of similar news.

User Recommendations

Notwithstanding, SAP should be included on almost any initial long list for global extended-ERP selections. SAP remains the ERP leader, and its strong resources and mind share give it the ability to weather impending storms much easier than most of its competitors in a similar situation.

However, existing and potential users currently evaluating SAP products, particularly its product components beyond the core R/3 ERP system, may benefit from considering already available and fully functional components from other vendors on the merits of individual components, instead of blindly following their brand loyalty (which may result in either waiting for a firm release date or putting up with sub-optimal functionality). Each component should be put through its paces using a well-documented set of requirements, scripted scenarios demonstrations and rigorous reference checking.

Future clients are also advised to request the Company's written commitment to promised functionality, general availability date, price, length of implementation, and seamless future upgrades, particularly for recently announced partnered offerings. SAP has traditionally been honest and forthright in addressing these questions.