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Microsoft-SAP: The E-Mail Trail

By James Kerstetter So it turns out the proposed merger that never happened between Microsoft and German software giant SAP started with a simple Saturday afternoon e-mail from Microsoft Chairman William Gates to CEO Steve Ballmer. It was June 7, 2003, the day after Oracle (ORCL) shocked the computer industry by announcing a hostile takeover bid for rival PeopleSoft (PSFT), and Gates wondered what Microsoft (MSFT) should do about it in an e-mail with the subject line, "PeopleSoft and SAP and us??"

"Thinking about this PeopleSoft bid by Oracle made me wonder if we should approach them and suggest a minority investment [in PeopleSoft] to bolster their independence in return for a modest platform commitment," Gates wrote in the e-mail. He added that it could be complicated, and then wrote, more intriguingly, "Another thought that came to mind is that it's time we bought SAP (SAP)."

Just like that, Microsoft's M&A machine went to work. By now, the outline of what happened next is well known. Microsoft and SAP executives talked for several months, but never got close to consummating a deal. However, internal Microsoft documents introduced in Oracle's antitrust trial in U.S. District Court in San Francisco on June 23, as well as testimony by a Microsoft senior vice-president, provide new insights into the talks' backroom machinations.

CRACKING THE CODE. The Justice Dept. has sued to block Oracle's $7.7 billion takeover of PeopleSoft on antitrust grounds, and Oracle is trying to prove that Microsoft is a legitimate enterprise-applications competitor. That Gates, Ballmer, and Microsoft were so intently watching Oracle's moves and figuring out ways to respond bolsters Oracle's case, in the view of the defense. Justice lawyers, on the other hand, argue that even mighty Microsoft must buy, rather than build, its way into the enterprise-applications market.

Microsoft execs, the documents show, clearly believed they had to react to Oracle's takeover bid. In a June 17, 2003, internal document called "Project Constellation," Cindy Bates, Microsoft's general manager for small business, explored the whys and wherefores of buying SAP, and what the combination would mean. The report is filled with code words: Microsoft is referred to as "Mensa," which is both a constellation and a well-known society for geniuses. SAP is called "Sagittarius," PeopleSoft is "Pegasus," and Oracle "Ophiucus," after the constellation representing the mythological physician Asclepius, who gained insight into life and death from serpents.

While Microsoft worried that Oracle's acquisition of PeopleSoft would rob it of some customers for its operating system and database software, the bigger concern was IBM (IBM) -- which is "Indus" in the report's codewords. Though no evidence suggests that IBM ever made such a move, Bates speculated that Oracle's brass-knuckle acquisition strategy would spur IBM to tighten its relationship with SAP, leaving Gates & Co. in the cold. Microsoft, she argued, should step in before that happens.

GAINING "MINDSHARE." From the beginning, of course, Microsoft execs acknowledged that acquiring SAP wouldn't be easy. "Negatives would be complexity," Gates wrote in his e-mail. "I don't think there would be regulatory issues, but that could be naive." Plus, he added, "It's not cheap."

Given SAP's $7 billion in annual sales and $38 billion valuation, Microsoft certainly would have had to spend big to buy the German company - though the exact figure Gates mentioned was blacked out, or "redacted," at Microsoft's request.

SAP would be a franchise of "unique" value to Microsoft, Bates argued. IT could help Microsoft get more "mindshare" with corporate chief information officers, help it sell more databases, and bring a complementary distribution channel for software. More important, it would block IBM from getting closer to SAP, a relationship that would have had a "very negative impact on Mensa's financial performance."

THE UNRAVELING. On the downside, Bates said, Microsoft would have to give SAP a significant amount of autonomy, and SAP's long-term position could face threats from new business models, such as software delivered as a service. Surprisingly, SAP would continue to run on software other than Microsoft's.

Not much happened for several months after that early research, Doug Burgum, senior vice-president for Microsoft Business Solutions, testified at the trial. In the fall of 2003, Ballmer met with several SAP executives to talk about usual partnership issues and broached combining the companies, Burgum told the court. Burgum said he thought Microsoft's Office desktop suite could be a terrific interface into SAP's complex back-office software.

In the following months, Gates and Ballmer met again with top SAP execs but "after some dialogue," the complexity of both the transaction and the integration of the two companies made them give up the idea by the spring of 2004. Knowing that the discussions were about to become part of Oracle's defense, both Microsoft and SAP put out a press release before Oracle's trial began acknowledging that a possible merger had been discussed.

Like so many historical "what-if's," no one will ever know for sure what might have been if Microsoft and SAP had tried to merge - or if Microsoft would have stirred up yet another round of antitrust bickering with the federal government. But certainly, such a combination would have made for a stunningly powerful company. Kerstetter is covering the trial for BusinessWeek

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