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11/15/2010
11:32 AM
Fritz Nelson
Fritz Nelson
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Oracle V. SAP: Writing Is On The Wall

At the halfway point of the tech trial of the year, we have solid clues as to what SAP will argue and what the jury will decide. Less certain is the lasting impact on the software industry.



With much of the Oracle-SAP trial drama spent, the insanity is giving way to mundanity: lawyers laying traps and expert witnesses parsing language to protect fat fees. The jurors must be wondering what sort of world we live in where companies tack on enormously profitable fees to patch, update and support products that take 30,000 engineers and billions of dollars to build. If Oracle and SAP were automakers, they'd require customers to buy the power train warranty to actually drive a purchased car.

When five weeks of trial proceedings end and three years of work winds down, 8 jurors will produce a single number, Oracle will be a little wealthier and a shamed SAP will manage to endure without missing a payroll. But the dark shadow of Oracle v. SAP will lurk indefinitely.

SAP's acquiescence is practically complete, having accepted both vicarious and contributory liability for the copyright infringement of its former TomorrowNow unit. It has also agreed to keep Bingham McCutchen LLP (Oracle's attorneys) swaddled in custom-tailored suits and country club dues for years with an agreement to pay Oracle's legal fees to the tune of $120 million. No word on whether that covers David Boies, for whom this is merely side work; he of DOJ v. Microsoft, California Proposition 8 and Bush v. Gore.

From here, SAP chips away at an artificial ceiling set by Oracle's damage expert, Paul Meyer: $1.66 billion. By accepting liability, it has avoided a public evisceration, as hard as Oracle has tried to deliver one anyway, and now SAP will cast itself as a victim of its own optimism and naiveté and demonstrate how it failed to meet its board's expectations for TomorrowNow. And because of this failure, it will hope the jury sees Oracle as the unreasonable victor intent on an excessive end-zone celebration. In German, Schadenfreude.

At the halfway point, what happens next is already becoming clear -- what SAP will argue, what the jury will decide and, most important, its lasting impact on the software industry.

The Difference Between $40 Million And $4 Billion

Oracle CEO Larry Ellison put the price tag at $4 billion. Perhaps he's looking for SAP to pay for a portion of the $11.1 billion PeopleSoft acquisition, the maintenance on "Rising Sun" (Ellison's yacht) and alimony to one of his first three wives. Oracle would like to base the damages on the "fair market value" for the licenses it hypothetically would have sold to SAP in January 2005, those hopeful days when SAP acquired TomorrowNow for a measly $10 million and began using the new company as the basis for its delusional Safe Passage program.

That program looked great on paper, but that paper is at the heart of SAP's undoing.

It turns out neither side would have actually undertaken such a negotiation. They've said as much, but it needs to be imagined nonetheless, according to Georgia Pacific v. United States Plywood (1970), a patent case that Oracle's team has successfully argued should be a basis for determining damages.

SAP only wants to imagine Ellison sleeping in a padded room with a dribble bib.

The court has also said that case is merely one consideration for the jury. Ron Epperson, national director of IP services at McGladrey, the fifth largest accounting firm in the U.S., said, "There is nothing in any copyright case law that says you have to use Georgia Pacific."

To imagine the negotiation scenario, each side is assumed to know what the other planned at the time -- in SAP's case, that its board had approved the TomorrowNow acquisition based on projections of cross-selling SAP products, and then up-selling competing products to PeopleSoft and Siebel customers who chose TomorrowNow's maintenance service instead of Oracle's. SAP's hopes were so high that it assumed $900 million in revenue growth by 2007 through the acquisition and conversion of between 2,000 and 4,000 PeopleSoft and JD Edwards customers. A veritable Wirtschaftswunder.

The $900 million number was stamped on emails between SAP executives and on board presentations, and many seemed to believe it could get better. In a conference call to announce the Safe Passage program, SAP board member Shai Agassi said, "What we believe is that this customer base is not necessarily captive by Oracle. I think this customer base has to make a choice right now."

In other words, rocked by Oracle's protracted hostile takeover and uncertain about Oracle's plans to replace all of its software with Fusion by 2008, if PeopleSoft customers were ever going to reconsider application decisions, it would have been right after the acquisition was finally approved.

Oracle's damage expert, Paul Meyer, used SAP's projected numbers to calculate many parts of his damage estimates, plugging them into a fairly straightforward valuation formula. For Oracle's side of the negotiation, he also used some of SAP's projections, ostensibly because Oracle didn't make any or failed to produce them for the trial. The breakdown: $1.5 billion for PeopleSoft license infringement, $100 million for Siebel and $55.6 million for Oracle database software material. Total damage: $1.655 billion.

SAP took issue with these numbers. First, using the fair market value argument, it claims that a negotiation would have resulted in a running royalty agreement, whereby SAP pays Oracle for licenses based on the success in using those licenses. Ultimately, SAP would like to base the damages on what it actually lost. The Safe Passage program garnered about 358 customers -- a far cry from the thousands of customers SAP hoped for. Of those, 86 customers bought SAP licenses.

Some of those customers would have left Oracle anyway, documentation shows. It's just that neither company can agree on how many. In fact, hours of trial time were spent debating how to count customers who had as much as a two-year (in some cases four-year) gap in service from TomorrowNow.

Meyer, Oracle's damages expert, actually provided the lost profit calculation SAP would like to use, but his numbers show $409 million.

Oracle's issue with either a running royalty or lost customer approach is both convenient and ideological. Just because SAP's Safe Passage failed miserably and TomorrowNow lost money doesn't mean that Oracle's software is worth less. Oracle co-President Safra Catz famously said it's like "someone taking your $2,000 watch, hocking it for $20 and now they want to pay you $20." While the analogy was a good sound bite, McGladrey's Epperson said it falls apart since "you still have your $2,000 watch . . . and all they got was the $20."

Despite having submitted lost customer damage figures, Meyer was adamant about using the fair market value approach, and never clearly said why, other than admitting Oracle has paid his firm some $4 million for his testimony. SAP attorney Bob Mittelstaedt identified cases where Meyer had actually used SAP's desired damage assessment approach, including Informatica v. Business Objects. In that case, Meyer also referenced what's known as "book of wisdom" (Sinclair Refining v. Jenkins Petroleum, 1933).

In Sinclair Refining, the plaintiff was allowed to look at actual unexpected success as a factor, not just the hypothetical negotiation based only on what was known at the time. Indeed, even in Georgia Pacific v. United States Plywood, one of the considerations is the "established profitability of the product made under the patent; its commercial success; and its current popularity." Another Georgia Pacific criterion includes the "extent to which the infringer has made use of the invention."

Meyer argued that Book of Wisdom applies in patent cases, especially where new or emerging technology is at issue. But in fact, both Book of Wisdom and Georgia Pacific can be used, at the judge's discretion, for copyright cases. "The standards in copyright cases [as opposed to patent cases] are subtly different," Epperson said. "The standard in copyright cases, if you look at the code, says actual damages and infringers' profits . . . . If it was willful, you can pile on top of that."

Courtroom Gymnastics

SAP attorneys argued this issue of willfulness during a brief session with Judge Phyllis Hamilton in the trial's second week. Because there were no star witnesses around and the jury was still eating doughnuts and drinking bad coffee, it may have escaped notice.

The only SAP board member to appear as a live witness in Oakland's U.S. District Court was the company's obdurate CFO Werner Brandt, who essentially argued that SAP was not liable. Because SAP had already agreed to liability, Brandt's German version of "kiss my ass" caused Judge Hamilton to practically shout at SAP's legal team: "Witnesses cannot come in here and disavow [liability]." She has given the jury instructions to disregard the offending testimony.

But SAP attorneys also argued that while they continue to stipulate the company's liability, there's a distinction between accepting liability and willingness to infringe. "We are entitled to argue we weren't willing to infringe," said Greg Lanier, SAP's lead counsel.

Clearly this line of reasoning, sure to arise again, is intended to spur the jury to downgrade its opinion of SAP from foolish to naive.

It might reserve the foolish label for damage expert Paul Meyer. To most casual observers, it seems as if Oracle has played an expert game here. First, get Ellison, Catz and former co-president Charles Phillips to bandy about numbers like $4 billion. Then, have the true expert come in and, using calculations based on fancy business metrics like discount rates and customer revenue multipliers, land on a much more "reasonable" number like $1.66 billion.

It was all working according to plan until SAP's attorneys took their swats at Meyer, impeaching his own testimony several times during cross-examination. By the time attorney Bob Mittelstaedt was finished, Meyer probably would have equivocated about what his name was. Not since Bill Clinton has a witness parried so clumsily. Even a jury made comatose by talk of Enterprise Resource Planning and automated download bots had to suddenly realize that Meyer's "expertise" extended into covering his ass.

SAP's expert witness, Stephen Clarke, has been observing Meyer for the past few days. Certainly, he too will remember who is paying for his testimony, but he would do well to provide at least a few straightforward answers under cross-examination.

While Oracle must live with any potential fallout from a jury that may think Meyer had something to hide, it will continue to play on what SAP is hiding, namely, what its executives knew and when they knew it. Oracle attorneys continue to press for the appearance of HP CEO and former SAP CEO Leo Apotheker, who they believe was given reports of TomorrowNow's infringement and who was a central figure in the TomorrowNow integration. But while David Boies may wish to put the former SAP CEO to the test on the stand, Apotheker's reluctance to appear also serves Oracle's purpose: What, pray tell, does Apotheker have to hide? Nevertheless, an HP employee told me last week that Apotheker had just been spotted at an HP function in Andover, Md.

In perhaps the last piece of testimony we'll see Oracle's side present, it quoted former SAP Chairman Henning Kagermann saying In 2007 regarding Oracle's lawsuit: "We have no intention to settle. Why should we. . . . we don't think anything is wrong in our company." In his video deposition, taken about a year later, Kagermann said that's what he believed at the time. He also said: "I'm of the opinion that TomorrowNow did inappropriate downloading. I'm not of the opinion that downloads are inappropriate."

The End Of Third-Party Maintenance And Other Consequences

Kagermann's statement is curious, not just because it casts him as an unwilling infringer, but because he could be arguing something that's at the heart of the matter, but no longer the heart of this case: namely, whether downloading software from Oracle's website actually constitutes copyright infringement at all. Certainly, TomorrowNow downloaded millions of files, thousands of them actual copies of software, and many more copies than it had customers by a long shot. Evidence shows that TomorrowNow didn't keep one customer's software separate from another's.

SAP hasn't a leg to stand on there.

In one instant message exchange displayed during forensic expert Kevin Mandia's testimony, Shelley Nelson, a key TomorrowNow executive who ran global support, approved the use of Robert Half International or Bear Stearns customer credentials for another customer whose credentials had expired. This exchange took place a month after Oracle filed its lawsuit.

SAP told me that its policies require any third-party support company to access SAP software on the customer's premises, or remotely through something like a Citrix environment, or through another form of remote control. That software cannot be stored on the third party's servers, unless there's an explicit agreement for the customer, which is not the norm. Companies like Accenture and IBM may provide forms of SAP support as third parties, but even those arrangements are dictated by particular license arrangements, including those companies owning copies of the software.

Oracle says it has similar policies but has not provided those details.

Seth Ravin, CEO of the fast-growing third-party support provider Rimini Street, which is now also tangled up in lawsuits with Oracle (Oracle has sued Rimini Street, and Rimini Street has countersued), argues that his company is completely within its rights to keep Oracle and SAP software environments and support material on its own dedicated systems on behalf of its customers. He termed this de facto arrangement "Industry Waiver."

"The customer has access to the application source code and has a right to customize," Ravin said. "You are entitled to all of the files: updates, fixes, documents, notes. If you want, we'll go get them, package them and deliver them to you." Rimini Street keeps each customer's environment separate from any other. And for about 30% of its customers, Rimini Street doesn't even keep any software at all.

Ravin, who was an executive at TomorrowNow before starting Rimini Street, said he's surprised SAP isn't fighting this point. However, given that SAP, like Oracle, makes huge profits on its support business, he's also not surprised that SAP would like to hurry this case along. "[SAP] has a vested interest in trying to get through this thing, even if it means paying a substantial sum of money," he said.

"This is a public execution," Ravin said. "It has nothing to do with money . . . It's nothing more than harassment and anticompetitive activity." In other words, Oracle is trying to shut down any company that might threaten the software maintenance business. Rimini Street isn't planning to back down, Ravin said, and his company's lawsuit seems to be about Oracle's attempt to restrict trade. An Oracle spokeswoman said Oracle "loves its third-party partners."

While Oracle loves its partners to death, customers could quickly get tired of the mudslinging. Some will be wary of third-party support options, finding themselves stuck with these hefty fees, which range from 20% to 23% of the list price of the software. Companies pay support for every license purchased, regardless of whether it gets used. Some may turn to software-as-a-service (SaaS) providers; neither Salesforce.com nor Workday would comment on what the impact of the trial might be for them.

And this could be an opportune time for Microsoft to make more corporate inroads for this particular class of software. Microsoft also charges maintenance fees, but customers say the company is more relaxed about pricing and policies.

Finally, customers will wonder about the financial impact on SAP. Ray Wang, principal analyst at Constellation Research Group, said that SAP generates a 30% profit margin on $12 billion in revenue a year, so half its profitability would get wiped out at $1.66 billion in damages. "It hurts their ability to acquire other companies," Wang said. Customers will want to know "whether they'll be innovating instead of spending money on legal fees." SAP co-CEO Bill McDermott would not comment on the financial impact to SAP. He's expected to testify on Monday.

Because only Oracle has presented its case so far, it would be incredibly irresponsible to speculate on a trial outcome. So here goes . . .

SAP has already agreed to pay Oracle $120 million to cover the company's legal fees for this case. The jury has had this $900 million number drilled into its head, and Oracle's damage expert has said "at least $1.66 billion," which is essentially the Oracle damage ceiling.

That means that somewhere between $1 billion and $1.66 billion is the starting point from which SAP can chip away. The fair market value conversation is just one set of criteria the jury could be instructed to consider. If the jury considers other factors, like what actually happened, then the number starts to go down from there.

There's a chance the jury will see SAP as willful in its infringement, either by virtue of the massive amounts of software downloaded, even after Oracle filed its lawsuit, or because SAP executives seem a bit defiant, and the jury may award the $1.66 billion, or even more.

It seems more likely that the jury will factor in the actual loss. They are, after all, only human. It's knowledge that they have, and that cannot be ignored. The jury must also be fair to Oracle. While these damages may be unprecedented, so to were the downloads, Forensic expert Mandia said he'd never seen anything close to the 22 TB of data his firm examined.

SAP's damage expert is likely to put forth numbers in the low tens of millions, and SAP's attorneys have already shown their hand here: SAP executives have called the documents showing $900 million in growth "marketing plans," not business plans, and SAP has provided what it calls business plans with far more modest numbers. Oracle's attorneys have portrayed these documents as TomorrowNow valuation numbers, which SAP hasn't refuted.

In other words, there's really little chance for SAP to settle this without paying dearly. I wouldn't be surprised to see the jury settle on something closer to Paul Meyer's $409 million figure for lost profits.

For Further Reading:

Oracle v. SAP: Daytime Drama

SAP Admitting Infringement In Oracle Case

Oracle V. SAP Trial Begins With A Bang

Oracle V. SAP: Courtroom Diary

Oracle-SAP Trial: Phillips Says SAP Owes 'Billions,' Oracle Can't Find HP CEO Apotheker

SAP CFO Werner Brandt Baffles Oracle As Trial Girds for Ellison

Oracle CEO Ellison Demands $4 billion in Damages From SAP

Oracle-SAP Trial: Oracle Damage Expert Lands on $1.66 billion

Fritz Nelson is the editorial director for InformationWeek and the Executive Producer of TechWebTV. Fritz writes about startups and established companies alike, but likes to exploit multiple forms of media into his writing.

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