Escaping the jaws of Microsoft

Since taking the reins of Germany's SAP last year, Henning Kagermann has hardly had a dull moment.

Kagermann assumed the role of chief executive officer at the world's third-largest software company in May 2003 after sharing the title for five years with SAP co-founder Hasso Plattner. But a month after Plattner moved aside, SAP's largest competitors sought to unite against the company.

First, rivals PeopleSoft and J.D. Edwards agreed to merge. A few days later Oracle, SAP's top competitor, responded with an unsolicited bid to buy PeopleSoft--a $7.7 billion deal that's since been contested by the government as anticompetitive.

The PeopleSoft acquisition bid sent waves through the IT industry and landed Oracle in court. But it also spurred Microsoft to approach SAP about a merger--a negotiation the companies disclosed during last month's Oracle antitrust trial. The talks didn't get very far, but their existence underscored just how much this segment of the software industry is in upheaval.

Kagermann recently talked to CNET News.com about his brief courtship with Microsoft, his competitor's antitrust woes, and why so it's tough to innovate when a company has 20,000 chief information officers to keep happy.

A lot of people were surprised to learn that SAP talked to Microsoftabout a merger. How serious were the discussions?
They approached us, and we listened, but because there was no deal on thetable, I cannot answer if we were serious or not. I think that startsonce you have an offer.

What was the deal breaker?
We were exploring what could be the potential benefit (of a merger) tocustomers. It was stopped in the early phases through exploring thequestion of whether we can both promise significantly more value to bothsets of customers.

Is there something particular right now in the enterprise softwarebusiness that's driving this apparent merger mania? One of thedisclosures coming out of the Oracle antitrust trial is that (OracleCEO) Larry Ellison has a long shopping list. It seems that this is nowgoing to be the thing to do for 2004-2005. How do you see the worldshaking out?
I think that because of this new architecture that is emerging--serviceoriented architectures around Web services--that the position and the way companies present their value will change. It's obvious that peoplequestion themselves. Companies--SAP included--are asking themselves what are the spots of hottest value in the future and how well are theypositioned there. I think every company in IT is reassessing itsstrategic position. I strongly believe this is the driver behind (thisacquisition trend).

Is it inevitable then that the enterprise software market is going tobe reduced to an even smaller number of key players?
I believe there will be a few large players with a comprehensiveoffering that enterprises--especially the larger ones--will more andmore look to because the more we support their core business processes,the more strategic the relationship becomes. It will reduce to anumber--I don't know if it is three, four, five, whatever--not one, buta few. I don't think there is space for many midsize companies becauseeither they become the more complete solution provider, or they stay in a niche and they cannot generate enough revenue to make the jump to the large ones. This middle-size, I think, will go out.

Where does all of this leave SAP? Do you need a merger partner?

I think every company in IT is reassessing its strategicposition.

We want to be one of the larger ones. We think we have the position. Wehave the market share, and we have the customer base, which doesn't meanyou have to do everything. But we get more and more clients who nowhave 50, 60, 70 percent of their business running on SAP. It meansthere's a push for us to complete our enterprise applications.

Speaking of Larry Ellison, what do you think European regulators will doif Oracle wins its case against the U.S. Justice Department?
I think to some extent they would follow the Department of Justice. Thisis not an official position of SAP, but just my personal opinion.

One of the big questions in the Oracle-DOJ trial was whether or notMicrosoft plans to sell applications software to big global firms andcompete head-to-head with SAP, Oracle and PeopleSoft. Considering yourrecent merger talks, what do you think?
Whatever I heard from (Microsoft) is that they are focusing on themidmarket exclusively. So they never talked about the "up market."

One software company that's getting a lot of attention these days isSalesforce.com, and their big IPO last month looks like a majorvalidation. Are you worried about them and their motto that thetraditional enterprise software model is dead?
No, it's not a model that could replace today's model. What Salesforceis doing is they pick a few services which are not strategic and givethis in a generic way to some clients. This would never replace customerrelationship management; it will never replace a suite.

If over time clients like this model, I think we are prepared to do thesame. But it's not, in any case, a threat to our model because who inthe world would ever give his entire customer-facing process to somebodyelse? Nobody.

Why not do what Siebel has done and go after Salesforce now? After all,you're looking for growth, and this appears to be a growing market.
Yeah, but rushing into it without a clear, good value proposition thatmight be a better one than what Salesforce offers makes no sense. Ithink we have some time. But I don't see a huge market, otherwise wewould do it.

Have you formed a vision for SAP over the next five years that perhapsdiffers from the vision of previous SAP CEO Hasso Plattner? Or is yourposition to just keep your head down and continue along the same path?
Last year, we started to define a five-year strategy. You will see usmoving to a complete enterprise services architecture, which will befinished in 2007.

IT budgets will not grow.

We are building all our applications based on one openplatform. We are separating our applications over time into more stablecomponents that provide services and bring faster innovation to thefirst-movers in the market. So we're trying to solve this issue of aninnovator's dilemma, of serving a big installed base that is moreconservative and new customers who want to be leading-edge.

The innovator's dilemma is an interesting one. How do you respond to thecriticism that SAP has been slow to innovate in recent years? Is it fairto say SAP followed rather than led some of the recent technologywaves, such as customer relationship management and e-commerce?
I think everybody has a different view on this. I think SAP, as viewedfrom the outside, might be slow because we sometimes enter a market at apoint when others are in. But when we enter the market, it's a promisefor our clients that we are successful and in for a long, long time.This is part of our value proposition, part of our reputation. SAPcannot enter a market and go out. We cannot, like Siebel, go to LatinAmerica and, when business is not coming, just step out. We can't. Thisis part of our brand.

Do these technological shifts you describe--Web services and newarchitectures--change who you consider to be the competition?
Web Services brings an overlap in the competitive landscape, you areright. Because of Web services, we now have some overlap with IBM. Wehave a broader overlap with Microsoft than five years ago, that's true.It's not black-and-white any longer.

Do these competitive changes make SAP more vulnerable to attack?
If you are not changing, then you might be vulnerable. But we have beenon this track now for already 18 months. Everybody is saying we areleading. Our clients feel we have the right pace. So I feel more thancomfortable. For us, it's an opportunity.

What's the big deal about Web services anyway?
People want to leverage their investments. There is no chance to comeback with the next killer app, and say, "OK, take everything out."They've invested too much. With enterprise services architecture, SAPcan help them leverage, bring total cost of ownership down and bring theflexibility.

This resonates well with our clients, and most important, it's notrevolutionary. The client would kill us if we would come with arevolutionary idea. What they want to have is getting their bucks out ofthe investment, while having a vision for the next year so that theydon't miss the trend and they have more competitiveness.

Are the days of the software megadeal gone? Will customers ever regaintheir appetite for really big software projects that SAP is famous for?
Customers are buying more incrementally. It's not the big replacement ofinformation technology infrastructure we used to see. So I think dealsize goes down on average. We have less large deals, but we have moredeals. I personally don't believe that we will come back to see olddays, but I also believe that we will see the bottom very soon.

Will IT spending bounce back then?
No, IT budgets will not grow. People look at total cost of ownership andthey all try to squeeze out and try, if they have 3 percent IT expenses,to bring it down to 2.5 percent--some bring it down to 2 percent. But,if you look at where really the value is created, it's with theenterprise applications, which is sometimes less than 10 percent (of theIT budget). Therefore what is a commodity today, such as hardware, Ithink will be cheaper and will go down. There is enough demand forapplications, so therefore the amount of application spending will grow(and) therefore the application market will grow.