SAP posted solid revenue growth and a strong increase in net income and cash flow for its fiscal year 2004. While...
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total revenue grew only 7%, SAP achieved 10% growth in both software and maintenance revenue.
The growth of these categories, careful expense management, and some currency assistance helped the company to grow net income by 22% and boost free cash flow by 27%. In his remarks during the financial analyst conference, SAP CEO Henning Kagermann said that 2005 would be a year of significant Research and Development (R&D) investment, with major attention to transforming NetWeaver into a "Business Process Platform" from an "Integration and Application Platform." The financial analysts didn't pay much attention, but AMR Research believes this is a very important message.
The Bottom Line: SAP is very secure financially and has built a commanding lead in most application markets. Over the next three years, we expect the company to use its R&D spending advantage to dramatically accelerate the rearchitecture of its products.
Rundown of the numbers
SAP finished another very good year in which it capitalized on the turmoil surrounding the Oracle-PeopleSoft merger to actually increase its domination of the enterprise applications market. Sales in the United States were the primary factor in the company's growth in 2004. Bill McDermott, president and CEO of SAP America, has rapidly transformed a struggling U.S. operation into SAP's strongest region. While he has certainly been helped by the recovery of the U.S. economy, this year's software revenue growth of 27% (38% at constant currency) is reminiscent of the good old days of the late 1990s. SAP America has been leading some of the organizational innovations in SAP's field operations and now boasts the company's highest level of customer satisfaction.
Product investment rises above margins
For the last several years, SAP's earnings calls have been dominated by discussions of margin performance and profitability improvement. The financial results for 2004 were certainly impressive, but SAP management clearly sent a message that for the next several years, product investment will be more important than additional margin expansion. It appears the company believes it is very important to quickly complete the transition to a Service-Oriented Architecture (SOA) before competitors like Oracle or Microsoft can bring their next-generation products to market. SAP is already investing far more in R&D (more than 1 billion euros in 2004) than any of its competitors, and it plans to add another 1,000 developers in 2005. The timetable now calls for SAP's Enterprise Services Architecture (ESA) roadmap to be completed by 2007, with the entire product suite and all industry-specific products available on a version of NetWeaver that will support business process management and orchestration.
A vision comes into focus
The names and technology buzzwords have changed, but the vision of breaking the enterprise application suite into a portfolio of configurable process components has been a key part of SAP's strategy for many years. The ability to assemble to order exactly the system required for a particular market, industry, or customer environment is the Holy Grail for a packaged software vendor. SAP may have finally reached the point where it has the technology, resources, and market conditions to take the leap.
SAP serves an incredibly diverse set of customers in dozens of industries, hundreds of countries, and a range of sizes, from 10 employees to 10,000 and more. Some of these customers want complete, integrated business systems while others are just looking to address one business issue right now. Today SAP struggles to make the mySAP and BusinessOne product lines fit every need. For the next three years, SAP will try to break its enormous collection of application functionality into a manageable portfolio of configurable process components. The idea is that SAP engineers, customers, or business partners will be able to use NetWeaver to create tailored processes that fit a specific need, integrate to an existing environment, or offer a distinct business model. SAP is convinced that this is the key to its continued market leadership and what its customers and prospects have been or will be looking for.
Conclusion: SAP is a company at the top of its game, but it is about to take a remarkable gamble. The hardest thing to do as a market leader is introduce a product or concept that directly challenges the paradigm that led to your success. There is no guarantee (or even strong indication) that the idea of buying a configurable set of process components or Web services will appeal to buyers that are used to buying predefined application suites. Even if the concept succeeds, there is no guarantee that anyone will choose to buy these components from SAP, or be willing to pay prices that approach today's Enterprise Resource Planning (ERP) license fees.
Unlike most multibillion-dollar companies, SAP continues to be run by engineers who are genuinely committed to the spirit of innovation and don't seem to worry much about job security. Today's announcement by Kagermann indicates that SAP is about to take its flagship product through a profound architectural change; SAP customers need to spend the time to really understand what this will mean for them.
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