Online Extra: SAP: A Software Giant Rarin' to Grow

The enterprise software leader's ability to provide support and innovation gives it increasing leverage as the business consolidates

By Jack Ewing

Once upon a time, software makers were high-growth and cutting-edge. Now analysts are comparing their products Yes, this is what software has come to. Yet the transition from sexy startup to a more predictable, dependable business could be a good thing for Germany's SAP (SAP ), the world leader in selling enterprise software. (Businesses use such programs to manage companywide accounting, supply, personnel, and other internal functions.) The strength of the business pushed SAP to No. 40 in BusinessWeek's 2003 Info Tech 100 ranking.

The thesis, proposed by analysts like Knut Woller at Munich bank HVB, is that software has become a mature industry. And the idea is that just as Michelin and Goodyear (GT ) dominate the tire industry, so SAP, Oracle (ORCL ), and a few others will "own" the market for corporate software. "The big, established vendors are in a good position to be long as they do not lose their ability to innovate," says Woller, who on June 2 published a 40-page report on enterprise software. Woller predicted that SAP's shares would rise from 95.25 euros to 110 euros -- a prediction that came true within a week.


  He notes parallels between software at the beginning of the 21st century and the auto industry early in the 20th. A period of frantic invention brought the number of auto makers in the U.S. to 274 by 1909. Then came a period of brutal consolidation. Mass production created high fixed costs and worked in favor of a few companies with access to capital and the ability to manage big, complicated organizations. As early as 1910, Ford (F ), General Motors (GM ), and Chrysler (DCX ) already produced almost half of the cars in the U.S.

The market for enterprise software is on the cusp of a similar development, says Woller. Oracle CEO Larry Ellison also seems to be an adherent of that argument: His hostile bid for PeopleSoft (PSFT ) is a clear attempt to take control of the consolidation process. Just as no domestic producer ever successfully challenged the dominance of the Big Three auto makers, first movers such as SAP and Oracle are likely to keep control of the software market. In fact, those two plus PeopleSoft and JD Edwards (JDEC ) already control 36% of the global market for applications software.

SAP didn't have any immediate comment for this article, but CEO Henning Kagermann plans to talk about these trends at Sapphire, a SAP users conference in mid-June. In the meantime, evidence shows the trend is already well under way. SAP's market share is growing even amid a tech slump and a weak dollar, which lowers the value of sales in the U.S., its largest market. SAP has defended its dominance among big corporations, which provide most of the revenue, while increasingly finding customers among midsize and small companies.


  Wait a minute, though. Could Woller be missing some crucial differences here? Consider how the business works. An entrepreneur with a good idea and the ability to write computer code can bang out new software with little more than a home PC. Production and distribution costs are insignificant. Customers can just download the program over the Internet.

Indeed, a few years ago, dozens of so-called best-of-breed software makers operated on that principle. They were small operations that concentrated on offering software that did one thing well. For example, Dallas-based i2 Technologies (ITWO ) was an early leader in software for managing far-flung networks of suppliers. For several years, the best-of-breed software companies stole market share from the biggies.

Yet these days the advantage is shifting back to companies like SAP that offer suites -- packages of programs designed to work together -- plus the support they require. Customers want the whole car, not just the tire, Woller argues. They also want reliable products and are turning especially to SAP, thanks to its reputation for not putting software on the market until it's well-tested.


  Likewise, dozens of best-of-breed competitors are now either folding or being bought out. And not many new ones are starting up. "There could be a comeback of the best-of-breed vendors, but I think it will only be in niche markets," Woller says.

The result: SAP boosted its market share to 22% last year from 16% in 2000, according to HVB, which predicts SAP will push its share to 27% by yearend 2003. More important, cost cutting and reduced competition from best-of-breed suppliers has allowed SAP to increase its profit margin. Its first-quarter net more than doubled, to $220 million, and HVB and other analysts expect SAP to boost full-year profits to $1.25 billion on sales of $8.6 billion. That's what you call burning rubber.

Ewing is a staff writer in BusinessWeek's Frankfurt bureau

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