As the Justice Department and Oracle face off, the competitive landscape for business applications takes an unexpected shift

InformationWeek Staff, Contributor

June 11, 2004

5 Min Read

It didn't take long for the complexity of the software industry to show just how hard it may be for the Justice Department to narrowly cast Oracle's proposed takeover of PeopleSoft Inc. Shortly before the doors swung open in San Francisco District Court last week, Microsoft and SAP disclosed they had recently broken off merger talks, a jaw-dropping revelation that illustrated just how quickly the competitive landscape could change.

The Microsoft-SAP bombshell alone would give pause to anyone assessing who competes with whom in the business-applications market. SAP is the market leader, and Microsoft an up-and-comer. What does it say about market dynamics when the up-and-comer has the wherewithal to consider purchasing the market leader--and the leader considers the offer from a position of strength, not weakness?

"The issue most likely to determine the outcome of this case is what the market is defined as," says Neil Herman, a software analyst with Lehman Brothers.

As the first week of the Justice v. Oracle trial unfolded, other sensitive inner workings of the industry also were laid bare. Oracle cited evidence suggesting IBM worried about losing millions of dollars in business if the deal went through. Oracle also pointed out that Verizon, which was testifying as a Justice Department witness, had negotiated free support from PeopleSoft when those two companies signed a software deal.

Lawyers huddled with U.S. District Judge Vaughn Walker to negotiate which supporting documents would be kept secret and which made public. At one point, Walker questioned Laurette Bradley, senior VP of IT at Verizon and a witness for the government, about why parts of a company document had been blacked out. Walker warned all sides he would take a "tougher line" on that practice, which could lead to the release of confidential contract information--or a reluctance among some witnesses to share such information at all.

The crux of the Justice Department's lawsuit to stop Oracle's acquisition of PeopleSoft is that it would reduce the number of vendors capable of providing financial-management and human-resources applications to large customers from three suppliers--Oracle, PeopleSoft, and SAP--to two. But Oracle argued there are other legitimate high-end application providers and introduced into evidence E-mail from PeopleSoft describing American Management Systems Inc. as "a very formidable competitor and a serious threat." Oracle also noted that the Justice Department itself recently awarded an applications contract to AMS.

SAP is the enterprise-apps market leader with, by its own estimate, 54% of the licensing revenue when measured against four competitors: Oracle (13%), PeopleSoft (12%), Microsoft (11%), and Siebel Systems (10%). SAP CEO Henning Kagermann downplays the potential impact of an Oracle-PeopleSoft combination on his business. "Honestly, if they were to become a really strong No. 2, then I would be concerned, but this is not the case," he said in an April interview. Why such confidence? SAP's licensing revenue climbed 5% last quarter--including a huge 45% jump in the United States--and Kagermann believes there's pent-up demand for business applications. The company is forecasting 10% license growth for the year. "Volume is there," Kagermann said.

A key point of debate in the courtroom last week was where to draw the line between medium-sized and large companies or those with varying levels of sophistication. PeopleSoft chief technology officer Richard Bergquist admitted under cross-examination that it can be hard to distinguish between so-called low-function and high-function companies. "I don't have any dividing lines that I've seen," Bergquist conceded.

Microsoft's emerging role makes it a wild card in the case. Microsoft Business Solutions' revenue climbed 21% to $471 million in the first nine months of the company's current fiscal year, and the division plans to release major upgrades to each of its four enterprise-resource-planning suites over the next 12 months. Despite the false start with SAP, Microsoft is sticking with its stated strategy of aiming primarily at small and midsize companies. Even so, Satya Nadella, a corporate VP with Microsoft Business Solutions, leaves some room to maneuver. If a large company is defined "as being made up of a lot of small enterprises," Nadella says, "then you're absolutely right, we'll definitely be in that business."

Verizon's Bradley expressed concern that Oracle would phase out PeopleSoft's applications. "The development of the PeopleSoft code base, its constant feeding and care, is critically important to us," she said. When an Oracle lawyer tried to prod Bradley into admitting she would still have negotiating room even if Oracle acquired PeopleSoft, she remarked: "You can tell me I have two loathsome options, but that's not going to make me much happier that I only have two."

Oracle contends it would not only continue to enhance PeopleSoft's applications but provide support for the PeopleSoft product line for at least 10 years. By comparison, SAP is giving its customers until 2012 to move from its older generation of applications, and Microsoft has indicated it will support the four ERP suites it has acquired--Axapta, Great Plains, Navision, and Solomon--until 2013, as it makes room for an entirely new set of apps in development now. Oracle's plan seems within the norm.

Yet even Oracle customers are sympathetic to the concerns of PeopleSoft users worried about eventually having to migrate to another application environment. "It's a very, very big job to convert a major system over," says Allen Fox, director of IT applications with Alcatel Internetworking Inc., a longtime Oracle customer.

Cost is the other big concern. Lehman Brothers analyst Herman says the cost of ERP software has been declining steadily in recent years, but he acknowledges Oracle would probably gain pricing leverage if it were to acquire PeopleSoft. "The Department of Justice has brought up some extremely valid issues," he says. Lehman Brothers has provided services to both Oracle and PeopleSoft in the past 12 months.

The outcome of the trial will only partly determine how things change in the applications market. Even if Oracle wins, it would still have to pull off the financial transaction. And by then, the unpredictable competitive landscape may already have shifted.

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