SAP Plants Its Flag in Mid-Market Territory with SaaS Apps

September 24, 2007 Timothy Prickett Morgan

Application software giant SAP certainly is not the first company to bring hosted applications to market on a subscription basis to the midrange market, but the German company’s top executives made it clear at the launch in New York last week of the forthcoming “A1S” product line, officially called Business ByDesign, that SAP intended to dominate the mid-market much as it currently does for applications aimed at the largest enterprises in the world. The stakes are high, and SAP took great pains to explain why it has moved slowly and deliberately as it chases the mid-market with a software as a service (SaaS) approach.

As SAP enters this market officially in early 2008, the company will face some familiar rivals. Oracle has been selling hosted versions of its Oracle eBusiness Suite for years, and the company’s founder and chairman, Larry Ellison, has a majority stake in an SaaS startup called NetSuite, which is preparing for its initial public offering. Last fall, Dave Duffield, the founder of PeopleSoft, which was eaten by rival Oracle in January 2006, launched a new SaaS enterprise application offering called Workday. And, of course, Salesforce.com has blazed the trail, showing that companies will trust software delivered under a SaaS model and pay a decent amount of money for it.

The SaaS application software market is something that SAP’s founders have been dreaming about for two decades, according Henning Kagermann, the company chief executive officer. A decade ago, when the Internet went commercial, the idea of selling software as a service was called application service providing, and it did not address some of the core concerns that midrange shops had when it came to acquiring software. So it comes as no surprise that ASP was a flop, and it will come as no surprise this time around that SaaS will not be. Not only has Internet, server, and middleware technology evolved, but application development has changed from being a set of monolithic modules glued together with hacks to a set of services that end users invoke and that are connected into an application. Moreover, after a decade of using the Internet, small and medium businesses, that cannot afford expensive IT talent and sophisticated, best-of-breed infrastructure, know that they can trust Web-based technologies to run their business. Or, more precisely, there is no reason to trust Internet-based applications any less than their own home-grown and cobbled-together applications, which often consist of a mix of spreadsheets, databases, PC applications, and server applications that are integrated through sneakernet more than software interfaces.

“This is not just a new product for us,” explained Kagermann, as he opened the launch event last week. “It is a new era for us, and we enter the volume market with an on-demand solution. I have been at SAP for 25 years, and this is the most important product announcement in my career.”

Those are strong words, considering how SAP rocked the application world in the late 1990s, establishing integrated enterprise resource planning for manufacturers, distributors, and retailers and quickly becoming the dominant supplier of software, thanks in large part to the R/3 client/server ERP suite, which was extended to the Web as the MySAP.com suite. But unlike R/3, MySAP.com, and their kickers, which are still sold today, the software behind the Business ByDesign service is, according to Peter Zencke, who is in charge of research and development at SAP and who steered the A1S project for the past four years to bring it to market, the first software on the market that was designed from the ground up to be a fully integrated solution to run an entire business and that was based on a services oriented architecture. Over 1,000 software engineers are working on the A1S project.

While SAP’s flagship Business Suite software is aimed at companies with 2,500 or more employees, Business ByDesign is aimed at firms with between 100 and 500 employees that can’t afford a full SAP implementation and do not have IT staff even if they could afford it. SAP’s All-in-One suite, which is a trimmed down set of software aimed at companies with fewer than 2,500 employees, and Business One suite, which is aimed at firms with between 10 and 100 employees, have given SAP approximately 28,000 small and medium businesses, that represent over 70 percent of its customer base. But they only represent about 30 percent of software sales each year. While SAP is expecting Business ByDesign to significantly increase its addressable market, to $75 billion from the current $60 billion, the fact remains that this software service is more about giving customers less complex software for a lot lower cost–but just high enough that SAP and its partners can profit nicely just the same.

The details of exactly how Business ByDesign is built were a little sketchy. SAP’s NetWeaver middleware is the foundation of the application, much as it is for the current Business Suite, All-in-One, and Business One suites, which are aimed at large, midrange, and small enterprises, respectively and which are licensed products, not sold as a service. (At least not by SAP, anyway.) On top of NetWeaver is an Enterprise Services Repository, which includes all of the services that SAP built for the suite as well as a means for hooking into third-party applications, doing mashups with Google Earth or Microsoft Virtual Earth, or hooking into outsourced applications such as payroll processing, popularly used by midrange companies. Rather than hard-code the software, Business ByDesign is created by modeling an application workflow and then having a tool create the code. Zencke says that four years ago, when SAP started on the A1S project, the kind of model-based application development tools the company needed did not exist, so presumably SAP invented them. (This is probably a bit of a stretch, since such SOA tools do exist today and have existed for years.) The user interface is a separate layer in the Business ByDesign suite, and the interface was created by a team SAP set up in Palo Alto, California.

The new SaaS offering is more than just a pretty face on old applications. It is a rethinking of how data moves inside applications. ERP systems were really designed as transaction processing systems for manufacturers and distributors which have had customer relationship management, supply chain management, business analytics, and other features bolted onto their sides as their legacy screens were modified for the Web. But Business ByDesign is organized according to the functions of a business and the tasks that employees perform. “The work should come to the people. They should not have to search the system for their work,” Zencke explains. And because everything is integrated, when a sales prospect is converted to an actual sale in the system by a few clicks of a mouse (a demo that Zemcke showed on stage), then the inventory for the company is updated, commissions for sales people and profit margins are calculated, and the entire system is updated wherever that transaction has an effect. And it takes just a second or two.

One of the big issues with multitenancy applications is guaranteeing the full isolation of the data and applications from one user from another who is sharing the application. Because Business ByDesign runs on top of the MaxDB database created by SAP and now co-developed in conjunction with MySQL and MaxDB has been equipped to provide database isolation–something SAP says other databases cannot do yet–the company is confident that it can provide the kind of security for data and applications that mid-market companies expect. The whole shebang runs atop Linux (SAP did not say which one), and it is rumored to be running on a set of blade servers. Considering that there are only 20 live customers and only another 23 in pilot, the amount of server capacity hosting Business ByDesign is probably only a couple of racks of gear at this point.

Over time, this will obviously grow, and if the Business ByDesign business grows as SAP intends it to, then it seems reasonable that some big companies with hosting experience will want to provide hosting services for the software as well as sell it to their customers. Kagermann says that SAP is planning to sell Business ByDesign to 10,000 customers between now and the end of 2009, and that in 2010 and beyond it will sell the service to approximately 10,000 customers per year. With the addition of Business ByDesign, SAP is now confident that it can reach its goal of having 100,000 customers by the end of 2010. The company currently has 41,200 customers worldwide, so this represents a huge increase in customer base. But, then again, SAP has identified 600,000 potential customers for this type of SaaS offering, and says that 1.2 million small and medium businesses worldwide are making do with a hodge-podge of spreadsheets, PC applications, paper, and email to do business–all of which need either a licensed software or SaaS offering from SAP or one of its competitors. SAP has identified 50,000 potential customers for Business ByDesign in the United States, and another 16,000 in Germany, where the SaaS product will be first sold.

According to Leo Apotheker, deputy CEO at SAP and president of the company’s global customer solutions and operations, SAP has 300 customers in the pipeline and is evaluating pilot clients in the United Kingdom, France, and China. As the service becomes available in early 2008, SAP will roll it out in additional markets, starting with Australia, Japan, and India in the Asia/Pacific region, Canada and Mexico in the Americas, and Italy, Spain, and the Netherlands in Europe (with South Africa thrown in). Other countries will be added to the mix in 2009.

While SAP is obviously keen on selling Business ByDesign, it does not seem to be in a big hurry to swamp the market. And that is because along with the SaaS offering comes a new sales model. With this product, SAP expects to have existing partners as well as new ones that it thinks it will be able to attract do all or most of the selling. These partners will sell the product and book the revenue and pay SAP a royalty. And because this is such a different revenue model than selling perpetual software licenses, even more implementation services, and charging for support, SAP is making a slow and deliberate ramp for the Business ByDesign products. The main reason, says Kagermann, is that SAP wants this product to be more profitable for customers–meaning it will have a higher profit margin–than current products, and presumably enough left over to give SAP a tidy and profitable revenue stream, too. The catch, of course, is that while the profit margins for the SaaS product will be higher, the software does not require system integration and customization services, and support is built into the price. So resellers will have to make it up in volume–as will SAP, since its own revenues for the A1S hinge on those of resellers.

To help those volumes along, the Web-based applications will be available on a trial basis, with all application functionality turned on, to pre-qualified companies (presumably qualified by resellers), so they can see Business ByDesign in action and not base their business decisions on a few demos and a prayer. This is taking a play out of the open source software book without letting go of the code. And it is smart.

Business ByDesign will go on sale in the United States first, at a cost of $149 per month per seat. Customers have to buy a minimum of 25 seats, which is another way of saying that customers who might be thinking they can dodge the Business One suite will not be able to. It is also a way of showing that SAP cannot make money on a dozen seats with the Business ByDesign suite–at least not yet. That user count will undoubtedly come down over time, and there is an even chance that Business One will be driven from the market if small and medium businesses go for the hosted model in a big way. Shops that have occasional or restricted users will be able to get Business ByDesign seats for $54 a pop in the United States. It is unclear what SAP will charge in Europe and other countries.

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