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SAP - Earnings, Competition & Business ByDesign

                       SAP - A Rethink Just Before Sapphire

For the last few weeks, I've heard unpleasant rumors about SAP. Because I don't spread rumors, I haven't helped the spread of same. However, the recent earnings report raised a number of concerns just prior to next week's SAPPHIRE conference.

This bombshell was in the investor documents provided to shareholders today:

"Small and Midsize Enterprises and SAP Business ByDesign
SAP’s small and midsize enterprise (SME) business continued to perform well in the first quarter of 2008 as the Company added more than 1,570 new SME customers (excluding customers from Business Objects) in the quarter, representing a 28% increase compared to the first quarter of 2007. A principal component of the SME strategy is SAP’s breakthrough innovative new solution, SAP Business ByDesign. Since last September’s announcement of SAP Business ByDesign, the Company has been working closely with early customers and partners to validate and fine-tune the solution. As a result of this process, SAP has elected to modify the rollout strategy for SAP Business ByDesign to ensure a more focused and controlled ramp-up process. The new rollout strategy includes the following:

• For 2008, go-to-market efforts for SAP Business ByDesign will focus on six countries, where all the current productive early customers are based and which represent a large amount of the worldwide volume market opportunity. Additional country rollouts will be executed in 2009.
• It is expected to take around 12 months to 18 months longer than the original 2010 target to reach the SAP Business ByDesign $1 billion revenue and 10,000 customer potential.
• However, the Company will use SAP Business ByDesign innovations and technologies for the existing solutions and this will contribute significantly to the overall revenues of SAP in 2010.
• Also, the Company will engage with significantly less than 1,000 customers in 2008.

In light of the modified rollout strategy, SAP will reduce its accelerated investments around SAP Business ByDesign in 2008 by approximately €100 million, which is expected to result in additional operating margin expansion in 2008 as noted in the “Business Outlook” section of this release. Furthermore, beginning in 2009 there will be no further accelerated investments. The expected expenses related to SAP Business ByDesign will be funded out of SAP’s normal operational business.

SAP maintains its full confidence in the product, the market opportunity and the associated business model of SAP Business ByDesign, as the Company continues to move toward volume readiness in 2008. " (Source: http://www.sap.com/about/investor/press.epx?pressID=9406)

SAP Business ByDesign has consistently been the most discussed product line within the Enterprise Irregulars whenever SAP products are discussed. Significant issues have been raised previously about:

• the channel program needed to sell this product. Was this channel economically attractive to providers?
• the ability to sell this product line. Do partners or SAP have the materials, collateral, training, etc. to effectively identify prospects and close deals? Can these be done profitably?
• the 50-100 customer per blade limitation
• the long-term strategy for the product. Would Business ByDesign become the future product platform for SAP? Would this eventually replace other product lines?

While Business ByDesign is a robust solution that SAP had consistently maintained would remain a SMB product, their announcement today would imply that parts of the solution may be utilized in other SAP products.

Behind these changes involving Business ByDesign are some hard economic facts:

• the effect of the falling dollar vis-a-vis the Euro has adversely affected SAP's earnings
• a review of their headcount showed that the company added a lot of positions in their North American operations. Specifically, the addition of Business Objects personnel has added materially to their ranks. Whether by design (no pun intended) or not, the company has grown the ranks of its Sales & Marketing, General & Administrative and Infrastructure headcount by 20-30%. (see attached graphic or follow link to full SAP presentation: http://www.sap.com/about/investor/reports/quarterlyreport/2008/pdf/Q1_2008_E_final2.pdf)   

The added effect of more personnel, slower sales of Business ByDesign and other factors caused total revenue to go up 14% while operating expenses increased 22%.

Going into SAPPHIRE, SAP management should expect questions such as:

• Will SAP embark on layoffs, especially in North American non-client facing personnel?
• What progress has SAP made in developing its Business ByDesign channel program?
• Has SAP improved the economics for channel partners for its Business ByDesign product?
• Will SAP share with us details involving the technical difficulties they are examining in the Business ByDesign product line?

On balance, the bulk of the earnings announcement was positive but not surprising. The company posted continued growth and new customer gains. The company continued to gain market share. However, the difficulties with Business ByDesign should cause investors to question whether this company can effectively take the SMB space as confidently as they have pursued large enterprises.

For those who caught Marc Benioff and Hasso Plattner at the Churchill event, Marc teased Dr. Plattner about building SAP on the Force.com platform. Today, that might look like a better on-demand/SaaS strategy afterall.   

The Money Behind TypoSquatting

                                         The Value of Misdirection

Check out this week's InfoWorld magazine in an article they produced titled "Dell suit reveals lucrative trade in domain names". (Follow this link: http://www.infoworld.com/archives/emailPrint.jsp?R=printThis&A=/article/08/02/05/Dell-suit-reveals-lucrative-trade-in-domain-names_1.html for the full story).

The article describes how four defendants have bought 1100 domain names that are similar to legitimate sites.  The typo squatters make money by redirecting these Web surfers to other sites.  Click through advertising revenue is the economic engine behind this activity.

What's interesting about this story is that Dell sought a court order to freeze the assets of these for firms in order to preserve any monies these operations have earned. They'll also accused the defendants typo squatting and domain tasting and once their profits as well as $100,000 per infringing domain.

Google's ad sense program is the moneymaking machine behind these domains.  For its part, Google has announced it will not permit ad sense campaigns on kited domains such as these.

Kiting domain names is like check kiting in payment processing.  Registrants quickly register and then delist domains within a five day grace period. The purpose of this grace period is to let regular folks like you and I cancel a domain registration should we make a typo in the initial registration.  However, kiters take it one step further.  Kiters buy a domain and immediately place Web referral pages on those sites.  If they see sufficient eyeballs hitting that site they will continue to own the site.  However, if the traffic is below economic requirements, this site will be released. Some sites are continuously bought, released, and, we registered to and other affiliate company.  That process triggers the kiting as the domain is effectively locked up yet no one ever bothers to actually pay for it. 

You can't say that entrepreneurialism is dead on the Internet.  This story just reinforces the lengths some will go to make a buck.

When Will Your Stock Be Worth Something

                         Liquidity Events Affect CEO Tenure

Recently, the CEO of a successful application software firm was 'promoted' to the Chairman's spot on the board. She was a great CEO who led her firm through the roughest parts of the dot.com bubble burst with skill and aplumb. Since the burst, she's actually grown the firm sensibly, held a few user conferences and grown the team and the client list.

But, CEOs don't always control their fate: major shareholders do. In situations like the above, the board was probably less interested in retaining a competent, reasonable growth (low capital appetite) oriented CEO and wanted a transactional CEO. Transactional CEOs are brought in to do one primary thing: achieve a liquidity event for the shareholders/investors. They don't care if the company is sold to a larger, publicly traded firm or listed for its own IPO. They want to see an event occur so that they can get their 10-50X back on their initial investment.

Professional investors, be they VCs or private equity firms, have a specific timetable for when they want to see their investment payoff. As such, they'll often force out founder CEOs once the company has been successfully launched or when they believe a transactional CEO is needed.

Personally, I don't care for a lot of transactional CEOs. They really don't give a damn about employees (the assets that made the company and products) or about long-term prospects/relationships. They come in, tart up the balance sheet, sell anything that can be sold at any price to get the revenue (and valuation) numbers up and then invite in prospective buyers.

So, say you want to launch a venture backed company. How long would you last as its CEO? Here are my estimates:

• Incubator CEO - This person market tests the concept, finds the killer team to launch the company and gets the first few sales. Great people person, deal maker but not a big company or grow a company at any cost person. Average Tenure: 1-2 years
• Growth CEO - This person is good at raising capital, managing cash flow, cajoling prospects, closing sales deals and working with the trade press. This person is a great face person for the company and gets solid business results. He/She does this without burning up equity too fast while still posting solid growth rates. Average Tenure: 4 years
• Transactional CEO -  This soulless individual would sell their own mother for the right NPV (net present value). He/She knows they are a short-timer yet acts like they have the employees' best interests in hand. Actually, this CEO needs to placate the workforce for a few months while a buyer can be arranged for the company or the IPO can be cemented. Average Tenure: 1 year

If you think these retention periods are off, consider this blurb that appeared in today's VentureWire (a cool service of DowJones):

Venture investors enjoyed one of the strongest years for exits in recent memory in 2007, but they're also waiting longer before seeing their companies go public or be acquired, according to industry data.

U.S. venture-backed companies raised $52.9 billion through initial public offerings and corporate mergers last year, according to VentureSource, a research unit of Dow Jones, publisher of VentureWire. That was the most since 2000, when a total of $117 billion was raised through liquidity events.

But the data also show that the median time to liquidity reached a record 6.7 years in 2007.

Investors want liquidity fast and they'll make major changes to a software company to achieve that liquidity event.

Yes, each of these CEO types plays an important role in a software company but too few software employees realize how different their fate and economic well-being are being affected by each. You can bet that the transactional CEO has crafted a pay package that rewards him/her massively for achieving a liquidity event. I know one individual who knew that any liquidity deal he would structure would not result in much of a windfall for himself as his stock options were common stock based and equity investors (with all of their preference and conversion rights) owned preferred stock. After the all of the overdue preferred stock dividends were paid and all of the preferred shareholders were paid out, there would be nothing left for common stock (i.e., employees) shareholders. Realizing this, this CEO added a carve-out provision to any potential deal he shopped to prospective buyers. He personally wanted $1-2 million set aside for himself and a couple of key employees. In actuality, he kept close to $2million for himself and further reduced the payoff to the preferred class investors. This same CEO was not a people person either. He ran off approximately 200% of the workforce in 24 months. Virtually no employee got anything when the company was sold. If you're an employee and your firm just got a transactional CEO, be very, very careful. Your equity may be worth nothing and this person may get you fired.

Getting SG&A Under Control

                            Oracle’s T&E Expenditures

I know Vinnie (www.dealarchitect.typepad.com) is always interested in what software vendors spend on sales, general and administrative costs (and, by extension, how little or effectively they spend their R&D budget). Since I don’t think any other blogger reads Business Travel News for the software stories, I thought I'd do Vinnie a favor and relate the following about Oracle:

 Total 2006 T&E spend = $585 million USD

 $244 of this in air volume 416,000 cardholders

 over the last seven quarters, Oracle's cost per transaction in the US and decreased 33% while transaction volume increased 50%

Oracle is reducing its T&E cost by consolidating the numbers of travel service centers from 91 to 12 and in requiring employees to book travel online. Online booking now accounts for 90% of transactions. Source: Business Travel News, 9/10/2007, “Only the Few Follow the Sun”

I have my doubts that the numbers reported in to that magazine represent all of Oracle's travel and entertainment spending. This is not a scientific assessment but just a hunch given the way large software companies sell to major corporations. For your own assessment I have included a snapshot from an actual page from the Oracle 10-K of 2005.

Why Get Value When You Can Keep Paying Millions!

        Why ERP Installers Get A Negative Rap

In a letter to the editor in this week's Information Week (www.informationweek.com, 8/14/2006), Randy Volters described what's wrong with the people implementing ERP solutions. He said:

"For larger vendors, this stems from their hiring model, which is too heavily slanted to hiring IT graduates out of universities. For the midrange vendors we deal with, the problem is that their distribution model relies too heavily on value-added resellers to implement systems. These companies are measured more on sales productivity than on their ability to install and keep customers happy... and it shows."

Amen.

Too many VARs are more interested in turning customers into never ending service annuities instead of delivering a first-class implementation. I've seen three VARs in a row fail to implement a one client's basic ERP solution.

Client satisfaction leads to more referrals which leads to long-term company and bottom line growth. Gouging the customers you have today just leads to ill-will, negative references and increased selling costs. Eventually, it leads to business failure. 

In a future post, we'll need to look at the vendor's culpability for their VARs short-comings.

Carr refines "IT does not matter" argument

At the recent Effective IT conference in London, industry sceptic Nicholas Carr kicked off proceedings with a modified version of the attack on IT in his book, IT does not matter. Jyoti Banerjee assesses whether the new version stacks up in the light of current IT experience.

(Right at the outset, let me just say thanks to Brian for inviting me to contribute to his blog. We've known each other for what seems like hundreds of years, but I doubt either of us would let a happenstance like that affect our opinions of each other's views. Our contrasting experiences and backgrounds - US versus European bases, Texan versus Indian backgrounds, etc - should help give this site a different twist on your screens).

Back to the matter at hand....

It was the Nobel Prize-winning economist from MIT, Robert Solow, who quipped that you could see computers everywhere except in the productivity statistics. In writing his book, Nicholas Carr was simply following in Solow's distinguished footsteps by attacking the value business has got from the massive investments it has made in IT. His argument was that IT does not provide competitive advantage to a business as there is little or no differentiation in the bulk of the technologies used by modern businesses.

Those for and against the argument have had a field day in the IT press, with both sides claiming victory through case studies and stats that prove their point and disprove the opposition. With Carr given the opportunity to rehearse his arguments in front of an audience of IT professionals in London, it was clear that the heat has not gone out of the debate, though one wishes for a little more light all around.

To differentiate or not

Let's explore the debate a little further. One could ask whether it matters that 70-80% of all IT is undifferentiated. After all, the implication could well be that at least 20-30% of all IT is strongly differentiated. Although the two statements are two sides of the same coin, they actually present quite different arguments.

Take the example of the car industry. Its products are largely undifferentiated (they have four wheels, four brakes, a steering wheel, a roof, an engine, etc) but the industry has created huge brand differentiation by focusing on the bits that are different (front-wheel versus rear-wheel versus all wheel drive, for example, or 50mpg versus 35 mpg, and so on). Although 70-80% of two cars may be undifferentiated in terms of the raw materials, there is no question that the buyer can distinguish a Ford from a BMW, a Hyundai from a Honda. is there really a difference between those cars that would justify their different brand strengths or company profitability? How is it that a company like BMW can go to the same suppliers as everybody else and yet deliver unmistakeably different brand performance in the marketplace? Maybe the differentiation is all done in the few percent of components that are actually different from one car to the next.

To me that would make sense in computing terms, as well. We might all use the same computers (undifferentiated) but the few that do smart things with their computers, or build smart processes around them (differentiation), could perform vastly better than the others. So to me, the case of differentiated or undifferentiated infrastructure, as presented by Carr, is not one that makes me say anything but "so what."

Hagel and Brown in their book The Only Sustainable Edge offer an interesting argument that the secret to competitive advantage is the relentless building of distinctive capability, within an organisation, plus in the networks it operates in. The implication of offering distinctive internal capabilities is that organisations have to choose what they are going to excel in, as it is not possible for any single organisation to excel in everything. By choosing to focus on what the organisation does best, it becomes mandatory for the organisation to then seek external partners who can provide world-class capability in those areas the organisation is not distinctive in. Clearly, the outsourcing impetus comes from those organisations that audit what they do and decide that in a number of areas they cannot compete with those that offer world-class capability. Instead, they join together in networks with those who can plug their gaps.

In effect, the Hagel / Brown argument would support Carr's position that a company should focus on what it is good at, and leave the rest to others who are better equipped to deal with those issues. Outsourcing started with infrastructural issues, such as IT and facilities. It has since progressed to cover horizontal activities such as accounting and payroll. Today, companies outsource things that a few years ago would have been regarded as core to their operating processes. Why should IT be any different? Why should IT professionals hang on to processes or skills within the organisation when their own competences are best employed elsewhere? In this sense, Carr is absolutely right: why should IT see itself as something special when it probably isn't, and should be handed over to a partner more competent in delivery.

Where I hesitate to hang my hat on the Carr coat-rack is in the area of utility computing. In becoming an advocate of utility computing, Carr is making it difficult for others to buy into his argument. The reality is that utility computing is still too new and too immature to be the mechanism by which enterprises can exploit quality world-class IT infrastructure. While many of the products already exist to enable utility computing, the two big gaps right now are in hardware and in process management.

Hardware

There are just not enough server farms around right now to allow utility computing to fly, despite huge attempts by all and sundry to build them fast. This is obviously a big enough gap that Microsoft has decided to spend a large part of its $35 billion cash pile on server farms in every location around the world they can find a big enough source of electricity. As these server farms come online, the hardware argument against utility computing will go away. Till then, there are no enough utility computing providers who have world-class capability to deliver the sort of infrastructure that tens of thousands of enterprises will need.

Also, all the server infrastructure cannot protect you from calamity when the evid day comes. Witness the outage suffered by MySpace due to record-breaking heat in Los Angeles where its data servers are held.

Processes

Of course, any new product can introduce change, even revolutionary change. More importantly, it takes time to deliver widespread change. It takes time to configure processes, enterprises, and now networks of enterprises together in such a way that the resultant meld of processes delivers competitive advantage of the sort that shows up in an economist’s productivity statistics. It took about thirty years before the impact of electricity could be measured across an economy because it took that long to figure out the best way to re-configure businesses in such a way that they could exploit electric machines, electric processes, etc.

We are seeing the same kind of reconfiguration taking place around digital processes. Eventually, that reconfiguration may well encompass utility computing as well. Till then, I can live with largely undifferentiated IT infrastructure if it allows us just a tiny room for innovation. Because that little margin of differentiation is often enough for people, smart people, to build competitive advantage.

That’s what the entire discussion about IT and its impact on business boils down to: People. Preferably, smart people. Now there’s an idea with legs….

Interesting Market Stats

                      Martin Wolf's  Channel Benchmarks

CRN published the following table a couple of weeks ago (see www.crn.com, 06/19/06).

(double to expand this image)

It shows some interesting gross margin, debt and EBITDA data for several outsourced services. You might want to remember this data next time you're negotiating a contract.