SAP Undermines Software Industry's Key Revenue Model (SAP, ORCL)

Includes: CTSH, ORCL, SAP
by: William Trent, CFA

The Inquirer (Australia) has an article on how SAP (NYSE:SAP) plans to undercut Oracle (NYSE:ORCL) on Siebel support. As we wrote before, software companies only receive a portion of their revenues from the original sale of software. Following the sale, the software maker typically receives a good deal of follow-on revenue in the form of service and maintenance contracts.

The services range from updates to customization and technical support. SAP is undercutting this model in a short-sighted attempt to hurt Oracle.

Typically, the enterprise (big business) end users who buy such software prefer to get the support from the original vendor. Large vendors frequently did not support the products of competitors for fear that doing so would clue customers in to the fact that these services are commodity-like. Each vendor protected its own margins by making it appear as though the other vendor’s products were also special and should only be supported by those vendors.

That changed somewhat with SAP’s 2005 acquisition of TomorrowNow, which had been an independent service provider for Siebel products. Independently, it had a tough time getting contracts, as customers preferred to buy the support directly from Siebel. Now, as part of SAP, there is a greater level of credibility and customers are more willing to buy such third-party support. In the short term, this allows SAP to profit from any success Oracle sees -- Oracle may win the software license, but SAP can still get the support deal.

Longer term, however, what SAP has done is show businesses that they don’t really need a name brand, let alone the original software vendor, to offer support. If SAP can support an Oracle application, why can’t IBM? Or better yet, offshore service provider Cognizant (NASDAQ:CTSH)? Does SAP think their customers won’t figure this out?

So long, juicy service margins at software firms.