SAP AG (SAP) has been an iconic leader in enterprise business applications since the launch of its Enterprise Resource Planning (ERP) R/3 in 1992. The company has achieved exceptional market dominance and sustained growth. Many Fortune 500 companies, such as Apple (AAPL), Nestle (NSRGY.PK), and BMW (BAMXY.PK) run their businesses with SAP software.
In 2009, software sales (€2,606M) plunged for the first time since 1992, at levels equivalent to 2004 (€2,361M) – 2005 (€2,783M). Software sales dropped 28%, while consulting and training were down by 17% and 37%, respectively. Support revenue climbed from 40% to 49% of the total revenue. The company’s position was to suggest that the financial crisis was to blame for its revenue drop. There were no signs at the time suggesting that SAP took steps to verify if there was something amiss internally. None of its competitors had equivalent setbacks, which suggests that this was an unrecognized, SAP-specific issue.
The downturn was the tip of the iceberg. Reviewing the company’s journey, it became apparent that the crisis was the result of a decade-long incubation process that gathered the ingredients of a structural crisis. The company accumulated vision mistakes, lack of successful innovation, poor new products, and unfulfilled promises. Most importantly, it did not pay appropriate attention to early warnings.
Two years of research connecting the dots over the period 1992-2011 unveiled the full extent of SAP’s crisis. A 365-page report titled “SAP Bubble Unveiled” (available at Teradots) presents the findings, supported by 693 source documents.
The report suggests that the starting point of the downturn was an absence of breakthrough innovation. By 1996, SAP had started to develop new products beyond its core ERP competency. Its efforts included the launch of CRM in 1996, Business Warehouse (BW) in 1997, database and mobility in 2000, middleware Netweaver in 2002, an appliance with columnar in-memory technology in 2005, CRM on-demand in 2006, and Business byDesign in 2007.
However, the new products fell short of expectations. They achieved limited customer traction, marketplace recognition, and contribution to SAP’s revenue.
SAP initiatives in the on-demand space have been a succession of vision and technology mistakes. The lack of vision can be identified as far back as 2004, when SAP announced that it would not enter the CRM on-demand space, and said that existing vendors would lose their customers. Nevertheless, SAP did jump on the bandwagon, but its first on-demand products, CRM on-demand in 2006 and Business byDesign in 2007 were built with defective platforms and consequently failed. SAP is now about twelve years late in the on-demand race.
The company assumed that the new products would have a quality equivalent to its ERP, and it delivered spectacular announcements. However, the products fell short of expectations. Little by little, as a result of product drawbacks, a pattern of broken promises started to surface. Customers started to buy from competitors, such as Peoplesoft, Siebel, Hyperion, Salesforce.com (CRM), SuccessFactors (SFSF), and BEA.
SAP’s sales revenue confirmed the lack of traction of products beyond ERP and Business Objects. According to Bloomberg, ERP produced 72% of software sales in 2010. SAP said this year that Business Objects produces 50% of the revenue in North America. Adding the sales of both products, there are limited percentage points available for all the other products lines combined.
The development of products and the acquisition of companies that have returned limited revenue has had a high cost for SAP. In addition, the company has been the target of legal allegations. The research has identified $1,900.7 million, in addition to billions in undisclosed amounts, spent in suboptimal expenses and legal costs.
Long-term unresolved customer complaints also contributed to customer discontent and to a deepening of the crisis in 2009. By 1995, customers started complaining about the complexity, rigidity, usability, response time, return-on-investment, costs of ownership, upgrades, and the value of SAP solutions.
SAP responded with diverse initiatives, such as TeamSAP and EnjoySAP in 1998, ValueSAP in 2000, Value Engineering and Netweaver/SOA in 2003, and mySAP ERP 2005 in 2004. Some promises became recurrent; for example, SAP promised to listen to its customers in 1998, 2002, 2006, 2007, 2008, 2009, and 2010, and promised value across the solutions lifecycle in 2000, 2003, 2005, and 2009.
Most of the issues remain open today because the core of the system is the same as in 1992; it has not been modernized. In 2010, Vishal Sikka, SAP Chief Technology Officer, mentioned that value has been a constant complaint. In 2010 and 2011, Lumber Liquidators (LL) reported that it had lost sales because of usability issues. In 2011, a global survey carried out by PA Consulting revealed that 43% of SAP customers are dissatisfied with the response times across all components.
To compensate for the lack of revenue from new products, the company introduced unconventional practices intended to create fresh revenue from existing customers. An example of this is that R/3 customers need to relicense the products that they already have to upgrade to ERP 6.0. In this regard, Gartner mentioned that combining new categories of items that have become payable has made the cost of ownership unpredictable.
SAP mentioned in 2006 that leadership is its main selling point. Certainly, companies tend to buy business applications from the leader. SAP mentions its leadership in almost all its PR communications, like a scripted message.
SAP started to lose market share in 2005 when Oracle (ORCL) introduced a strategy based on buying best-in-class products. The license revenue ratio of SAP over Oracle moved from 4.6 in 2004 to 1.8 in 2010. However, SAP’s loss of market share is more important because license revenue numbers as such do not tell the whole story.
According to the analysis presented in the report, SAP evaluations of peer group share include up to ten categories of revenue for itself and only one for its competitors. Assuming this analysis is right, SAP claims of peer group share appear distorted in its favor by degrees of magnitude over the last decade. SAP presented peer group share evaluations on its earnings calls at least from 2002 Q2 to 2008 Q3, then peer group share claims became occasional.
A fair evaluation of the market share in business applications must include only this category for all competitors. SAP reports only one number for its license revenue called “Software Revenue” that includes business applications, technology, and several other categories. SAP does not disclose the amount of license revenue corresponding to business applications. Consequently, it is impossible to evaluate market share for business applications. With the license revenue ratio of SAP over Oracle at 1.8 in 2010, it is not feasible to determine if SAP is still the leader. Indeed, if the diverse categories included in SAP “Software Revenue” beyond business applications represent more than 0.8 of the ratio, SAP would no longer be the leader in business applications.
With the license revenue as disclosed, the most accurate approach to evaluate market share is to include business application and technology for all vendors. This finding is a fundamental departure from the current practices that compare SAP Software Revenue with only applications license revenue for SAP’s competitors.
The number of customers reported quarterly by SAP is also a subject of controversy.
The combination of all the above aspects prefigures an ideal scenario for a perfect storm. Customers became upset in 2009 and SAP sales started to be affected. Hasso Plattner, SAP founder and chairman, acknowledged that customers had lost trust. According to a survey published in February 2010, employees had also lost trust. Describing SAP’s situation, some analysts used expressions such as crisis longtime in the making, erosion of trust and momentum, focus of frustration, need to make fewer serious errors, on the ropes, and risk to become less relevant.
SAP reacted in February 2010 with an impromptu executive shakeup. Leo Apotheker resigned just seven months after becoming sole CEO. The company appointed two insider Co-CEOs, Bill McDermott and Jim Hagemann Snabe. The move was widely considered as triggered by a crisis, not just by the poor results of 2009.
The new executives introduced an ambitious vision based on listening to customers, SAP HANA, mobility, the cloud, and extending the use of Agile development methods.
The current most promising innovation is SAP HANA, an appliance with columnar in-memory technology enabling fast processing and near real-time analytics. According to SAP, HANA has the potential to become the next-generation system architecture, removing the use of middleware and relational databases.
However, the root causes of the downturn appear outside the perimeter of the company transformations: product development, continuous customer complaints, and the 20-year aging ERP that represents the core of the customer base seem to remain unchanged.
Agile is probably not enough to address the long-term issues of product development. Most likely, Agile is not the solution to fifteen years of trying to get CRM right, or to making three platform mistakes in three on-demand initiatives (CRM on-demand in 2006, Business byDesign in 2007, and SaaS Enterprise in 2009).
The company has been trying to persuade the market that it is back on track. In this regard, spectacular announcements and outstanding success presented in quarterly results are routine.
However, connecting the dots has unveiled a different picture.
The results in 2010 and 2011 confirmed the downturn that emerged in 2009; that is, customers keep buying less from SAP. The software sales in 2010 (€3,265M) reverted to 2006 (€3,003M) – 2007 (€3,408M) levels, and in the first nine months of 2011 (€2,226M) the software sales reverted to 2008 (€2,283M) level. None of SAP’s competitors has experienced a similar regression. This is the outcome of the vision and execution mistakes that SAP accumulated during the last decade.
Business Objects, HANA, and mobility may give the company a break. But the core of the customer base is ERP, and SAP has not announced plans to develop a modern product. HANA might improve the response times and reduce the cost of ownership of the Business Suite, but the complexities of the aging ERP remain unchanged.
The customer base may be increasingly at risk, as it happened with CRM and Talent Management. If SAP decides to develop a modern ERP, it will probably arrive too late. Will SAP continue to get the customer base back as it intends to do with the announced acquisition of SuccessFactors? Is this their new business model?
HANA, on-demand, and mobility have yet to prove success. HANA revenue in the first nine months of 2011 was €61 million; subscription revenue decreased by 8% year-over-year in 2011 Q3, and mobility revenue has not been disclosed. It seems that the most important challenge that SAP is facing at the moment is to turn around long-term adverse track records in product development and execution.
Senior executives left the company in 2010 and 2011, including the leaders of key development areas. Last June, Constellation Research published an article titled “SAP and The Hoover Dam” which mentions that some people are saying that SAP seems unable to retain key people
By all accounts, SAP is no longer the leader it was. Some people could argue that 2011 Q3 was the best third quarter in the history of the company; I would respond that this has been a sales prowess, whereas the structural problems remain intact.
Is SAP getting it right? Here is a summary of the points to keep in mind to answer this question:
- SAP R&D has yet to deliver its first truly successful product since 1992 (it could be HANA overtime)
- The core of ERP that holds the customer base is outdated
- There seem to be no plans to develop a modern replacement product
- Development of a potential new ERP would take years
- Sales have declined stepping back by 3 to 4.5 years
- SAP’s leadership is questionable
- According to Gartner, the revenue from relicensing R/3 to ERP 6.0 is ending
- Customers and employees have lost trust
- Executives have been leaving
- On-demand is not making progress
- The customer base is increasingly at risk
- Analysts estimate that HANA could produce just 10% of the revenue by 2013.
There is a gap between the buzz and the hard facts.
Disclosure: I am long ORCL; I have Oracle stock for more than five years with no buy/sell activity in that period or planned in the immediate future.
