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During the Oracle-PeopleSoft antitrust trial, Microsoft was described as an ERP giant-killer. But its presence in enterprise applications has fallen short, so far.
Norm Alster, CFO IT
September 15, 2004
For an operation that has fallen short of expectations and been a consistent money-loser, Microsoft's business-applications unit certainly gets a lot of attention.
As part of its seemingly endless effort to acquire PeopleSoft Inc., Oracle Corp. responded to federal antitrust charges this summer by describing Microsoft Business Solutions (MBS) as a growing threat to its own enterprise-applications business. Oracle contends that Microsoft is intent on taking its relatively new unit, built largely through acquisitions, upmarket. While MBS ostensibly targets small and midsize businesses today, Oracle argues, Microsoft is working hard to position the unit as a viable option for large enterprise buyers of software that runs financial, manufacturing, human resources, and other key corporate processes. "There can be no reasonable doubt that Microsoft will increase its focus on larger enterprises over time," said Oracle in a filing in the San Francisco federal court where the antitrust case was awaiting a ruling at press time. While some analysts were ready to dismiss this as a transparent effort by Oracle to paint a more competitive picture than really exists for ERP and related software, Microsoft added fuel to the fire by acknowledging that it had discussed a possible acquisition of ERP giant SAP AG nearly a year ago but eventually dropped the idea.
These mixed signals have created confusion over Microsoft's intentions, but a closer look at MBS suggests that it lacks the necessary products, the near-term product development road map, and the distribution model to compete with Oracle, SAP, and PeopleSoft. True, Microsoft could buy its way into a market whose sales are already showing signs of peaking, but only at enormous cost, both in dollars and management attention, and probably in organizational cohesion. That's why few rivals, analysts, or customers think Microsoft is anywhere near mounting a challenge to Larry Ellison's Oracle.
"I've seen a lot of speculation about this, but I've not seen any evidence that Microsoft is addressing large enterprises," says Cory Eaves, corporate vice president, solutions management and research, at SSA Global, which competes with Microsoft for midsize business sales. Paul Hamerman, vice president, enterprise applications, at Forrester Research, agrees: "My take is, not now and at least not for a few years, if ever." And Jim Shepherd, vice president, research, at AMR Research, says, "I don't believe they are seriously interested in becoming a high-end ERP player."
Microsoft executives have also consistently disavowed designs on the large-enterprise-applications market. Tami Reller, corporate vice president at MBS and former CFO of Great Plains Software (which Microsoft acquired in April 2001, instantly becoming a major player in the midsize applications market), says her unit targets businesses with $1 million to $1 billion in sales. "We've been very consistent about that target market," she says.
In fact, given the company's continuing troubles with antitrust regulators in Europe and Asia, concerns over security vulnerabilities (see "Flagging on Security?" at the end of this article), the growing threat from open source software, the decision to delay a long-anticipated feature in the next major release of the Windows operating system, and recent disappointing sales in the small-to-midsize market it claims to be concentrating on, one could wonder how Oracle CEO Ellison could keep a straight face when billing Microsoft as a promising player in high-end ERP.
In the 12 months ending March 31, MBS did manage to grow revenues by 21 percent, but growth was a disappointing 4 percent in the March quarter. For the year ended in June, MBS achieved $804 million in revenue, but that is light years from the $10 billion business Microsoft managers predicted a couple of years ago. (Those were "aspirational" forecasts, says Reller.) Heavy ongoing investments in both research and development and expanding the reseller and independent software vendor partnerships that are usually key to serving midmarket customers have also contributed to continuing losses in the MBS unit.
In the hope of goosing that sluggish performance, Microsoft has shuffled the management at MBS in recent months. Senior vice president Doug Burgum now reports directly to corporate CEO Steve Ballmer, who has hosted several planning sessions with MBS executives. Ballmer's increased involvement is a sure sign that Microsoft is dissatisfied with the unit's results but considers the business important enough to soak up top management's attention. "Steve has a history of getting involved when a business struggles. If it's something that's critical to Microsoft business, he wants to get close to it," notes Chris Alliegro, lead analyst at Directions on Microsoft, an independent Kirkland, Washington, research firm that focuses on Microsoft.
As one possible sign of lowered expectations, Microsoft has cut back on the lone development program that offered hope of future sales to large enterprises. The company recently reassigned 130 engineers who had been working on Project Green, next-generation software built around Microsoft's .Net (pronounced "dot-net") Web services platform (for more on the implications of Web services, see "Coping with Complexity"). Some had cited Project Green as further evidence of Microsoft's upmarket ambitions, but analysts now say that due to cost concerns and delays in the related Longhorn project (the next generation of the Windows operating system), Project Green probably won't bear any fruit until 2007.
The cutbacks in Project Green may also reflect Microsoft's concern that it will cannibalize sales of existing products. "I think Microsoft decided that they need to sell what they have now," says Alliegro. Microsoft executives now emphasize that most MBS research is going toward enhancements of the unit's current product lines, which will be supported by Microsoft until at least 2013.
So with products suited solely for smaller customers, ambitious next-generation development slowed, and acquisition of high-end market share a costly and dubious proposition, two questions remain: How is it that Ellison professes to be so fearful of something so unlikely? And why was Bill Gates at least momentarily intrigued by what now seems a half-hearted courtship of SAP?
One theory comes from Jay Coughlan, CEO of Microsoft rival Lawson Software, who speculates that Gates may have been fretting more over the theoretical costs of not getting into the high end than over the very real and prohibitive financial and managerial costs of buying in. Gates, he says, may have worried that a continued lack of high-end ERP offerings would hurt Microsoft's efforts to peddle database, server, and other software to large customers.
Some analysts dismiss the notion that Microsoft needs to be selling high-end ERP software. "It's not critical for Microsoft to sell their applications to large enterprises in order for them to be successful in selling such other products as Office, operating systems, and databases," asserts Hamerman. And despite setbacks on several fronts, the company did return a stunning $75 billion (over four years) to shareholders, hardly the sign of a company that needs to hitch its star to some other entity. And the politics of partnerships cut both ways: if Microsoft did choose to move up, that action would turn potential partners like SAP and PeopleSoft into outright rivals.
In any event, the idea of acquiring SAP seems to have originated in a breezy E-mail from Gates to Ballmer ("Another thought that came to mind is that it's time we bought SAP."), only to be borne off as the winds shifted. Microsoft executives realized it would be an organizational nightmare to integrate the two large firms and that any such bid would have almost certainly been challenged by antitrust regulators. In addition, most observers think paying rich multiples to buy into a market whose slowing growth suggests impending saturation would be a folly. What's the lure of selling business applications to the Fortune 1,000, when "most have already selected their vendor," wonders AMR's Shepherd. "And besides, there are only a thousand of them."
By contrast, the universe of small and midsize businesses adopting financial and manufacturing software around the world is huge, fragmented, and largely untapped. Burgum recently told a conference of Microsoft partners that there are at least 12,000 SMB applications vendors addressing a market predicted to reach $35 billion by 2008.
Having spent more than $2 billion to acquire applications vendors Great Plains and Navision Software, and having melded a network of thousands of resellers, Microsoft now has, despite recent disappointing sales, a solid foothold in that market. Shrewdly, the company has focused on bringing ease-of-use to small businesses that do not often have the resources to deal with complex programs that may upend existing business processes. Microsoft also touts its ability to smoothly integrate business applications with the core software it already sells, including Microsoft Office, Exchange, Outlook, and SQL Server. Indeed, that software sometimes represents a smaller company's total IT infrastructure.
But the software and business model Microsoft has developed to sell to SMBs would not work for larger enterprise customers. For one thing, Microsoft markets through an army of 8,000 resellers, very few of which are equipped to handle large corporate customers, observes Coughlan. "A larger company will not buy that model. They want more services than the partner can provide."
Meanwhile, the four Microsoft ERP product lines — Great Plains, Navision, Solomon, and Axapta — are simply not suited to the needs of huge multisite, multinational corporations. In making its argument that Microsoft is moving upmarket, Oracle offered the court a list of larger companies in which it claims Microsoft challenged Oracle for ERP contracts. CFO IT contacted the companies on that list. Most refused to comment, but those that did made it clear that Microsoft couldn't meet their needs.
In late 2002, Herbalife International, a purveyor of nutritional supplements and weight-management products, was looking for an ERP suite to run its financials, supply chain, and manufacturing. To support the company's 2,300 employees working in 59 countries, such software had to fulfill special requirements. For example, it had to be able to address various statutory requirements for financial reporting in a multitude of national jurisdictions.
"It was quickly decided that Microsoft wasn't it," says Herbalife CIO Aldo Moreno. "We quickly realized that they could not support a company our size." Herbalife chose Oracle instead. Of Microsoft, Moreno says: "My personal opinion is they're nowhere near a PeopleSoft, SAP, or Oracle. They could not provide a fully integrated system that would support Herbalife globally."
Also unimpressed with Microsoft was Mustang Engineering, a Houston-based designer and manager of oil and gas facilities and structures that is an independent services provider of Aberdeen, Scotland-based Wood Group. Although Wood Group, with annual revenues of around $1 billion, is at the low end of the enterprise-class market, Mustang CFO Meg Lassarat indicates that Mustang's revenues are $250 million to $500 million, squarely in what's considered the high end of the SMB market. Even so, while Microsoft's Great Plains software did become 1 of 10 finalists out of 250 software packages initially evaluated, it ultimately fell short. The Microsoft software simply did not have the robust functionality to handle the financials of a multinational with complex equity ownership positions, according to Lassarat.
"They were unable to address some of the complex consolidations in the report writer functionality," she says. "They did not have full functionality for our kind of financial reporting." The Microsoft software also lacked another capability that many large engineering, construction, and defense contracting customers require — the ability to do sophisticated project-level financial reporting.
But for smaller businesses with less-complex accounting and reporting requirements, the Microsoft offerings tend to compete extremely well on price and ease of use. At Thomas Nelson Inc., a Nashville-based Bible publisher, the Microsoft Great Plains product triumphed over offerings from PeopleSoft, Oracle, and others. Vice president of information technology Rick Proctor was looking for an applications suite to handle core financials — everything from accounts payable to general ledger, cost of product, and financial reporting — for up to 100 users. This was clearly Microsoft's sweet spot. "Microsoft was a better price value than Oracle and PeopleSoft," says Proctor.
The competition for Thomas Nelson's business reflects the flip side of Ellison's argument that Microsoft is pushing up-market. In fact, upmarket players such as SAP and Oracle have been pushing down, trying to expand sales into smaller businesses, which may be far more logical than for Microsoft to attack the large-enterprise space.
Bitter rivals for so long, Ellison and Gates do seem fated to slug it out in the business-applications market. But, Ellison's recent testimony notwithstanding, it may be midsize rather than enterprise customers that find themselves heavily courted by the two software giants.
Norm Alster has worked for Forbes and BusinessWeek and is a contributor to The New York Times.
|Small, but Gaining
Despite disappointment to date, Microsoft's ERP revenue growth rate suggests a force in the making.
|2004 revenue rank||Company name||Revenue 2002||Revenue* 2004||Percentage change|
|4||Sage (Best Software)||$886M||$963M||8%|
|5||Microsoft Business Solutions||$412M||$804M||95%|
|*2004 revenue forecast
**2004 includes revenue from J.D. Edwards acquisition
Source: AMR Research, 2004
Flagging on Security?
"Success," Graham Greene once said, "is more dangerous than failure; the ripples break over a wider coastline." No software company has had more success than Microsoft, but as a result, its vast coastline is a destination for hackers and virus writers of every persuasion, from misguided amateurs to malevolent pros.
Microsoft has taken a lot of heat in the media and from industry experts for leaving its coastline exposed, and has stepped up security efforts on several fronts. Some of those moves, such as its Trustworthy Computing initiative, date back several years and attempt to address flaws in several ways, including building better security into products, helping customers use them more securely, and communicating more openly about vulnerabilities.
Several key product lines, including the XP desktop operating system and Windows Server 2003, are due to get upgrades that include substantial security fixes, and its new Internet Security and Acceleration Server 2004 includes such security advances as deeper content inspection. At its Worldwide Partner conference in July, Microsoft said that more than 90 million computer devices are now getting automatic updates, up from 12 million to 18 million 10 months earlier. In the same period, the number of servers receiving Microsoft automated updates rose from 55,000 to 112,000.
"This shows our commitment [to better security]," says Gytis Barzdukas, director of product management for the Microsoft Security Business and Technology unit. "We've moved past the world where we leave customers to themselves, and are being much more responsive than in the past." As one measure of the company's success in this regard, Barzdukas points to the declining number of "critical" or "important" security bulletins issued. In the first year after the release of the Windows 2000 server, there were 42 such bulletins issued; in the year after releasing Windows Server 2003, Microsoft issued only 13 such updates.
Security entails more than plugging holes where hackers can get in, however. Microsoft says it is also addressing authentication and access control by enhancing password administration for its servers and supporting smart cards and public-key infrastructure. In the future, it will support biometric identification cards. The company is also educating customers about security risks through free training programs for IT professionals, teaming with antivirus software developers in security consortia, and working with law enforcement agencies to share information about vulnerabilities.
But are these efforts enough? Analysts and IT security managers are encouraged by the initiatives, but they aren't ready to declare that their concerns about the security of Microsoft products are over. "I look for Microsoft to show more leadership in making products" more secure and articulate a clear vision of how it will address enterprise security challenges, says Eric Ogren, senior analyst at The Yankee Group in Boston. "They are communicating updates in an open manner and being accountable. But when it comes to [new product development], I just don't see anything innovative."
Ogren would like to see Microsoft accelerate efforts to prevent such common security holes as buffer overflows and provide more "cleaning" services via the Internet for customers that have experienced virus or worm attacks. He believes joint efforts with security vendors may be a good way to achieve some of this.
At Manufacturers Life Insurance Co., Edward J. Liebig, assistant vice president of global IS security, says Microsoft has made notable improvements in releasing vulnerability data and securing products. Nevertheless, Manufacturers Life remains cautious. "We want everything field-tested first, and we don't want to be the ones doing it," says Liebig. "We'd rather let the products sit out there and have the first or second patch revisions [completed] before we adopt them. You've got to show us these products are secure."
Liebig also believes Microsoft needs to work closely with security vendors to thwart attacks. "Security vendors should get a good opportunity to review any new product to ensure integrity of the security safeguards. No one vendor can go it alone," he says. "You need specialty partnerships to do best-of-breed development work for security in different areas."
Howard Schmidt, former White House cybersecurity adviser and now vice president and chief information security officer at eBay Inc., is pleased by Microsoft's security efforts and says the company has been soliciting more feedback from corporate security executives.
Schmidt says he has met with Microsoft representatives about six times in the past four months to discuss security and new product development. "They're being very proactive in working with the people who are responsible for security," he says. Clearly, Microsoft hopes that Schmidt's views ripple through the corporate market. —Bob Violino