SAP Rolls ‘Game-Changing’ Dice After 2006 Stumble

SAP  today announced that it increased revenue and
earnings for 2006, but that margins took a hit for a better cause.

Last year’s revenues rose by 10 percent, to 9.4 billion euro ($12.2 billion),
versus 8.5 billion euro ($11.1 billion) in 2005. Net income came in at 1.9
billion euro ($2.5 billion), 25 percent higher than the 2005 figure of 1.5
billion euro ($2 billion).

Operating income for 2006 was 2.6 billion euro ($3.4 billion), 10 percent
higher than the 2005 figure of 2.3 billion euro ($3 billion), but
operating margins fell one-tenth of a percent compared to 2005, from 27.4
percent to 27.3.

Moreover, the company warned investors that margins would continue to suffer
in 2007 and 2008, as the company committed itself to spending between $300
million and $400 million over the next eight quarters on a brand-new
strategy and platform aimed at mid-market companies.

SAP CEO Henning Kagermann said he expects that by 2010, SAP will be adding
10,000 new customers per year, versus 2,000 per year today, in a market he
valued at $16 billion. Kagermann was speaking at an analyst conference this

SAP stock, which closed at $50.02 in New York on Tuesday, fell by almost 5
percent in morning trading, as investors tried to digest the news.

Enterprise software vendors with their eyes on the huge but fragmented small
and medium business (SMB) market will also be watching closely. SAP promised to launch the new technology platform and business model aimed at this market segment in March 2007.

“We believe this is a game-changing product… with a lot of breakthrough
innovations,” said Kagermann. The new product, code-named A1S, can be deployed quickly and easily without the need for consultants and with a variety of ownership and payment options.

Kagermann, calling it “a suite in a box,” said that it
will offer SMBs more than just customer relationship management (CRM) or ERP
 functionality, but will span all business processes needed
to run a company.

He also said it will “eliminate risk” by allowing customers to run trials
before they commit to purchasing or subscribing to the service.

Another key element of A1S, according to Kagermann, is the variety of ways
that customers will be able to pay for it. It will be available as a hosted
service in 2007 but, beginning in 2008, will also be available in on-premise
and hybrid formats for which SAP will provide the financing if needed.

Kagermann said the company’s new approach will “bring down the cost of
ownership by a factor of 10” because SAP has changed “the entire business
model of how software is sold, distributed and maintained.”

The flip side for SAP is that it will continue to invest on the
infrastructure and delivery model, thus constraining margins in the near

But Kagermann expressed confidence that the investment will pay off with
margins that are even higher than pervious highs for the company. In fact,
he said that the only way for SAP to continue being a growth company is to
aggressively enter the SMB market.

SAP is crashing a market already addressed to varying degrees by several
competitors, including Oracle ,  and Microsoft .

But Kagermann dismissed comparisons with competitors’ efforts in the
mid-market as irrelevant. “Microsoft did it with a traditional product and
business model. You cannot do 10,000 new customers with mySAP; that’s not
the point,” he said.

Josh Greenbaum, principal analyst with Enterprise Applications Consulting,
said that S1A could bring “the real promise of real SOA  to
mid-market companies.”

And Merrill Lynch analyst Raimo Lenschow said in a note this morning that he sees investor confusion about margins as an opportunity to buy more stock.

“Clearly management must be thrilled about its medium- [and] long-term
prospects to sacrifice short-term margins to this extent. We agree with the
management view.”

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