A Changing Enterprise

The software giant hopes to reach out to new customers: small and medium-size companies. It’s likely to butt heads with tough competitors — namely, Microsoft and Google.

Henning Kagermann is anything but flashy. A former lecturer in theoretical physics who joined enterprise software giant SAP in 1982 and succeeded co-founder Hasso Plattner as CEO in 2003, Kagermann has quietly focused on organic growth. In contrast, Lawrence Ellison, his high-profile counterpart at arch-rival Oracle Corp., has spent some $19 billion acquiring smaller players, such as PeopleSoft and Siebel Systems. For a while, flying under the radar paid off for Kagermann. Even as customers of SAP’s merging competitors worried about integration issues, the company boosted its market share in the key enterprise-resource-planning software market, from 35 percent to 43 percent. The Waldorf, Germany, company’s shares soared from barely $20 each, when Kagermann took over, to $57 in April.

Now circumstances may be changing. Investors are growing concerned about a slowdown in SAP’s core business — licensing software for managing customer relationships and other business processes to multinationals. In July the company’s shares fell by 5 percent on the news that software revenue had grown by 8 percent in the second quarter, well below investor expectations. Oracle also appears finally to be getting its act together, gaining market share, albeit slightly, in recent months.

Industry watchers also speculate that SAP could be acquired or merge with a competitor. In late 2003 and early 2004, it talked with Microsoft about a potential combination. Then, in May, Plattner added fuel to the fire by publicly suggesting that SAP could be an attractive takeover target. Kagermann has since been telling everyone who will listen that the company strongly prefers to remain independent. (Plattner, who still owns 11 percent of the company, chairs SAP’s supervisory board but has no operational responsibilities.)

Kagermann, 59, is pursuing bold goals for organic growth, including doubling SAP’s $57 billion market capitalization and nearly tripling its customer base, from 36,000 to more than 100,000, by 2010. One means to that end: investing in such fast-growing markets as Brazil, China, India and Russia. (Slightly more than half of the company’s revenue comes from Europe, with a third originating in the Americas and 13 percent in Asia). Another focus will be launching a lower-cost version of SAP’s enterprise applications for small and medium-size companies. For added motivation, SAP announced in May a $381 million incentive compensation plan for top executives and key employees, linked to the four-year goals. Some employees — and other critics — in Germany have cried foul, calling the potential rewards disproportionate to rank-and-file workers’ pay.

Kagermann is keeping an eye out for new competitors. SAP has been running up against Microsoft more often as the markets for consumer and enterprise software converge. In November SAP teamed up with the Redmond, Washington, company to launch a product called Duet, which enhances the performance of Microsoft’s Office programs when paired with SAP’s business-process applications. Google is also spending some of its huge cash hoard on developing enterprise software. Kagermann recently discussed these and other issues with Institutional Investor Senior Editor Justin Schack.


Institutional Investor: Are you surprised that your stock price fell so sharply after you announced disappointing sales growth in July?

Kagermann: I didn’t expect that reaction. Our software growth came in below expectations, but there was marginal improvement in earnings per share, which were above expectations. We also confirmed our guidance for the year, so I didn’t feel that there was something fundamentally wrong with the business.

Some companies lately have dropped guidance altogether. Is that something you’ve considered?

No, because if we don’t give guidance, then the market gives guidance. I don’t want to be depending on the models that analysts have. I feel that yearly guidance is a good compromise. We say what we believe we can do. It’s not too short-term.

Oracle has gained back some market share from you lately. Is its acquisition spree finally starting to pay off?

I think so. I think if you spend too much money on acquisitions, there is a point in time where something has to pay off. I think that their customers might have been waiting a little bit on what happened with their acquisitions. Once you can secure them and calm them down, then I believe your installed base will continue to buy. Switching vendors is not that easy.

SAP has lots of free cash flow, very little debt, operates in a maturing industry and hasn’t had much stock-price appreciation lately — all the hallmarks of a leveraged-buyout candidate. Is going private a possibility?

That’s really speculative. If you look at our shareholder base, we have a healthy mix between long-term and short-term investors. Our three founders are also still major investors in the company. And we have reiterated several times that SAP is a strong company, is independent and will be independent in the future because our large customers have indicated a preference for that. I think the best thing is to do what customers want from you.

How will you achieve such goals as tripling your customer base and doubling your market capitalization?

We’ll bring a lot of new products to the market. We will be going to the middle market more than we do today. We want to gain market share, but we also want to expand our addressable market, so that our growth is not limited by the market we are in today.

How is serving smaller companies different than catering to multinationals?

Midmarket companies are concerned about price, but they also want ease of deployment and a complete solution that helps them to grow. All of these companies have the ambition to grow, and when that happens, they don’t want to have to install different software.

Were you surprised at the negative reaction to the bonus incentive plan you unveiled earlier this year for top executives and key employees?

I have to say I was surprised. But it wasn’t that negative from my point of view. I thought it was well received among the people at our annual meeting and in the newspapers later on. People said, “Okay, if they really can double the share price, that’s so many billions for the shareholders that it really doesn’t matter if the key employees and the boss get something.”

There’s a lot of talk these days about companies forgoing U.S. listings because of Sarbanes-Oxley. Are you considering that?

We have no intention to delist. The U.S. is our largest market. Most of our investors are there. For me, this is part of the game. I think the U.S. decided to have Sarbanes-Oxley for good reason. You can debate if it’s a little too much regulation, but we have no issue with it. We fulfill the requirements. Being that we are a software company, we use our own IT, so that helps. It’s not really impacting our business negatively.

Which parts of the world are you investing in right now?

Everybody is going into the BRIC countries [Brazil, Russia, India and China], and they are interesting for us as well. Russia is the biggest of the four for us, maybe because it’s so close to our headquarters. But our growth rate in all four of them is much faster than in any other country.

What are the challenges of doing business in those places?

It depends on which country you’re talking about. In China everyone wants to see better intellectual property protections. In Brazil there’s a special tax to protect local industry, which I think is not very fair. In India people sometimes complain about the infrastructure, such as the telecom and the streets, which could be better. I think Russia also has — a few issues [laughs].

Why wouldn’t you agree to a merger if a compelling deal presented itself?

It’s no secret that we had some talks with Microsoft some time ago. Many customers came to me at that time and explicitly stated that they would like SAP in the future to stay like it is today. That’s a big statement. We have a very large installed base, and there is always the risk in a merger that you lose part of your market. We also offer products that play on different technologies, so in that way there’s some neutrality to SAP — we can partner with many different companies.

What can you do to prevent companies like Google from invading your turf?

Google is offering services for enterprises, it is true, and these are good services. But I view them more as complementary to our software. SAP software, in most cases, is installed on the premises and running the entire business. What you see from Google today is mostly around productivity. Some of that can link to our product. They are not offering functionality that overlaps with ours. If it does, it is minor.