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Despite a fourth-quarter and full-year 2006 earnings report Jan. 24 that came in below par, SAP is forging ahead with plans to invest heavily in the midmarket with a new services-based product and business model. SAP said it hopes the plan will increase its earnings by $1 billion over the next four years and triple its customer base.

But in the short term, SAP’s evolving model reduces the company’s operating income. SAP said its midmarket investment—$370 million to $493 million (300 million to 400 million euros) over the next eight quarters—will likely have a negative impact on its operating margins in 2007, and that it expects its margins to drop from 2006’s 27.3 percent to between 26 and 27 percent this year.

At the same time, the company has changed its reporting structure to reflect the move to a services model. Beginning this quarter, and also for the full-year 2006 report, SAP added a new revenue line item called “subscription and other software-related service revenues.” It’s also replacing the line item dubbed “product revenues” with “software and software-related service revenues,” or the total of software revenue plus maintenance revenue.

SAP tallied the 2006 software and software-related services line item at $8,563 million (6,605 million euros) for 2006. The company’s 2007 outlook calls for a 12 to 14 percent increase at constant currencies, compared to a 12 percent increase the previous year.

The change in reporting structure obfuscates SAP’s full-year license sales, some analysts said.

JP Morgan analyst John Segrich said in media reports that the change in SAP’s reporting indicates that the company’s full-year license sales will likely increase by 10 to 12 percentage points. SAP had initially projected about 15 percent growth in license sales.

“The challenge here for SAP is that they are coming off a year where they missed their license guidance, and now investors are going to be struggling to figure out what this new guidance means,” Segrich said.

The traditional line item for license sales is an indication to analysts—and investors—of software demand, which in turn indicates the outlook for maintenance and service revenues.

Henning Kagermann, SAP’s CEO and executive board member, outlined the company’s midmarket strategy, a “game-changing” product and business model, and the build-out of a new delivery, operational and support infrastructure, during the Jan. 24 earnings call, but gave few details on the actual product.

The goal with the midmarket expenditure is to attract the current “non-buyer” with software that’s easy to implement, configure and use, on demand or as a service, he said.

Although SAP currently offers a CRM (customer relationship management) on-demand product, the shift is a big one. It means moving from the traditional model of selling custom software to the enterprise market, and receiving hefty annual license revenues from those sales, to selling subscription software where software is available “on demand” and revenue is received on a monthly basis.

The on-demand model has been exemplified by, a company that started with a CRM product and evolved into an on-demand platform provider. The success of underlies the pressure traditional software vendors like SAP face in staying current with emerging technology. Kagermann, in his presentation, said, “Time to market is essential.”

Click here to read more about the challenges facing SAP in 2007.

Still it’s not clear how much SAP plans to follow the subscription-based pricing model standardized by and other SAAS (software as a service) providers.

“On demand is just one of the 10 to 15 changes [we intend to make],” Kagermann said during an analyst presentation of SAP’s quarter and full-year earnings. He added, “Subscription—this is only one piece.”

SAP will disclose pricing for the new suite, code-named A1S, at the end of the quarter. “It will be competitive,” Kagermann said. The new midmarket pricing should have no impact on the enterprise market, according to Kagermann, given that SAP recently changed its enterprise pricing structure “and customers really like it.”

For its fourth quarter, SAP reported product revenues of $2.85 billion (2.2 billion euros), an increase of 12 percent at constant currencies compared to the same period in 2005. Software revenues for the fourth quarter were $1.69 billion (1.3 billion euros), an increase of 12 percent with constant currencies compared to the same year-ago quarter. Total revenues for the quarter came in at $3.89 billion (3 billion euros), compared to 2005’s fourth-quarter revenues of $3.63 billion (2.8 billion euros)—another increase of 12 percent in constant currencies.

For the full year, product revenues increased to $8.56 billion (6.6 billion euros), a 12 percent increase compared to 2005. Software revenues for the year also increased 12 percent to $4.02 billion (3.1 billion) versus $3.63 billion (2.8 billion euros) for the same period last year. Total revenues for the company came in at $12.19 billion (9.4 billion euros), an 11 percent increase over 2005.

SAP said its share of the enterprise application market grew to 24 percent worldwide—a gain of 2.8 percent for the year. SAP said that number represents a market share more than twice the size of its next closest competitor, Oracle.

Nonetheless, SAP’s earnings report was a miss, compared with not only analyst expectations, but its own guidance.

However, “While we did not achieve all of our targets in 2006, we ended up with solid growth at constant currencies for both product revenues and software revenues—the fourth quarter alone marked our 12th consecutive quarter of double-digit growth in software revenues at constant currencies—and at the same time we improved profitability,” Kagermann said

As for quarter and full-year highlights, Kagermann pointed to several milestones, including the migration of over 4,000 customers to MySAP ERP 2005 (SAP has about 35,000 customers) and the release of the first enhancement packages for the suite. MySAP ERP 2005 is SAP’s next-generation enterprise resource planning suite, which taps the company’s 4-year-old SOA (service-oriented architecture) investment. It’s also the starting point for any of SAP’s 35,000 customers that wish to follow the SOA path. In 2006 SAP said it would hold ERP 2005 steady for five years and release upgrades in the form of enhancement packages.

Read more here about SAP’s plans for the midmarket.

In the fourth quarter of 2006, SAP announced several new customers, including a global enterprise agreement with Unilever—SAP’s first global consumer-packaged-goods customer.

Also in the quarter, SAP, along with Microsoft, sold more than 200,000 licenses for Duet, a joint development project between the two companies that exposes SAP processes in Microsoft Office.

For 2007 guidance SAP said it expects full-year software and software-related services revenue to increase between 12 and 14 percent at constant currencies; in other words, to remain flat or to increase slightly above 2006’s 12 percent increase.

“2007 will be the year in which we successfully complete our road map by delivering services-enabled versions of the MySAP Business Suite and our established midmarket solution SAP All-in-One,” Kagermann said. “Also in 2007 we will begin delivering on what we believe is the most innovative solution in the industry designed specifically for new segments in the midmarket—a consumption-ready solution that provides our customers with fast time-to-value, quick and easy user adoption, high flexibility, [and] low TCO [total cost of ownership], and is built by design on a fully enabled enterprise services-oriented architecture.”

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