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By this point it’s no secret that SAP is investing heavily in the midmarket. The company is planning to spend between $370 million and $493 million (from 300 million euros to 400 million euros) over the next eight quarters in building out a new suite of enterprise application software that is both agile and appealing to IT-starved midmarket companies.

While SAP has said it will unveil the new suite in March, there are still a lot of questions left unanswered. Mainly, what will the suite consist of? What will it look like?

During his presentation to investors as part of SAP’s Jan. 24 earnings call, SAP CEO Henning Kagermann danced around the details of the new suite, code-named A1S.

“We are combining the power of the new platform that SAP has developed over the last three years [NetWeaver] with a new approach in the way software is delivered and consumed, to reach a broad segment of midsized companies with requirements not addressed by either traditional or on-demand solutions available today,” Kagermann said.

The A1S suite will coexist with SAP’s Business One suite, geared toward the lower end of the midmarket, and SAP All-in-One, a suite based MySAP ERP (SAP’s latest enterprise resource planning suite, based on service-oriented architecture) geared toward the mid- and upper midmarkets. Kagermann said he expects AS1 will open new markets for the company, generating about $1 billion in business for SAP by 2010.

What does SAP plan to offer that’s so different from what’s already on the market from competitors and NetSuite—not to mention Microsoft, which is developing its own suite of applications that will leverage an SOA and services-based model?

Clearly there’s going to be an on-demand component to A1S. SAP announced during its earnings call, which covered its fourth quarter and full-year 2006, that for that period and in the future it would replace the product revenue line item with something called “software and software-related service revenues.” At the same time, the company added a new line item: “Subscription and other software-related services revenues.”

But, according to Joshua Greenbaum, principal of Enterprise Applications Consulting, A1S could also involve appliance-based ERP.

“This is an old model for the midmarket that goes back to System 36; turnkey systems that turn on and start working with very little database administration [needed] to start working,” Greenbaum said. “It’s business in a box. Giving businesses pre-configured [applications] that you turn on and run could be very powerful for them.”

SAP has been dabbling quite a bit with the appliance concept. In 2006 it introduced its Business Intelligence Accelerator, an analytic engine for NetWeaver (SAP’s integration platform) that utilizes in-memory technology to enable very fast query processing—and has no requirements for an underlying database. Essentially an appliance, the BI Accelerator bundles hardware and software in a single package.

Click here to read more about SAP’s disappointing earnings reports and its plans for the future.

To create the BI Accelerator, SAP has partnered with Intel, which provides the processors, and HP and IBM, which provide their respective server and storage technologies. It’s not inconceivable that SAP could partner with the same companies to put business applications in a box for the midmarket. Taking the speculation further, it’s not hard to imagine that SAP would look to verticalize an ERP-based appliance by building, with partners, industry-specific processes rather than pre-installed, pre-configured application suites.

Judith Hurwitz, president and CEO of IT research firm Hurwitz & Associates, said she believes SAP has a good start in building the necessary components for an on-demand suite—modularized products, streamlined code, a Web 2.0 browser interface and reliable support.

“They are making progress. Has SAP figured it out? Probably not,” Hurwitz said. “If you look at, a lot of their wins have been in the midmarket, [companies] that say, ‘I want to do sales force automation but I don’t want a system administrator, I don’t want to buy hardware,’ so they’re very happy to do software as a service. But to take something much bigger and complex like ERP and apply the same philosophy [is challenging because] there are a lot more moving parts that are a lot more complex.”

Hurwitz pointed to another complex issue for SAP: figuring out how much to invest in the on-demand business model. Getting money once a month under the subscription model instead of getting it upfront through the traditional perpetual license structure can affect not only a company’s bottom line, but also how investors look at the company. “And once you open the flood gates to that, who is to say that companies that are much larger than midmarket,” won’t move to the on-demand model, Hurwitz asked. “In the long run, SAP might make more money [with on-demand sales]. In the short run, it can impact the bottom line.”

Next Page: Revenue misses mean SAP must prioritize its midmarket push.

Given SAP’s recent software revenue misses—its second and fourth quarters in 2006 fell short of expectations—and the response to those misses, SAP has really had to move its midmarket strategy to the front burner, according to Greenbaum.

Part of the challenge of entering the midmarket relatively quickly lies in building an indirect channel that can effectively sell SAP’s services. That effort has been in the past an uphill battle for SAP—a company that has traditionally sold its enterprise software through a direct sales channel. That said, SAP has done a tremendous amount of work in the past year building out an ecosystem around NetWeaver.

According to Kagermann, some of SAP’s future investment will go toward developing “new customer engagement models and a large and diverse partner ecosystem.” Earlier in January, SAP formed an SME (small and midsize enterprise) unit headed by Hans-Peter Klaey, who will oversee the go-to-market strategy, organizational alignment and multichannel delivery for the new midmarket suite. SAP also aligned all of its partner programs under a single umbrella, dubbed Partner Edge—a critical move in building an indirect channel.

“This market has to be sold through a partner channel. Traditional direct sales won’t work,” Greenbaum said. “The channel is where the rubber hits the road. It’s going to be something SAP is going to have to work hard at. The good news is it’s SAP, and a lot of companies will want to work with them. The bad news is the onus [on partners] is proving against the old SAP that is complex and not fit for the midmarket.”

The challenge when it comes to developing an entirely new on-demand suite, according to Zach Nelson, CEO of on-demand ERP provider NetSuite, is the time it takes to do it right.

“NetSuite is the only company that has an ERP-based on-demand business suite, and it took us eight years to build the product up to meet the needs of midsized companies,” said Nelson, in San Mateo, Calif. “So if SAP introduces an on-demand suite that has only been in development for a year, it won’t have the functionality needed by QuickBooks customers, much less a midsized enterprise.”

Granted, a hefty portion of Nelson’s company is owned by Larry Ellison, the CEO and co-founder of SAP nemesis Oracle. But Nelson brings up an important issue: the time it takes to build a reliable on-demand service and support organization., the poster child for on-demand software, has been in business since 1999. Last year, amidst explosive growth, the company experienced some persistent issues with downtime that resulted in some customers losing access to their CRM applications for hours at a time—the industry standard for uptime is “five nines,” or 99.999 percent of the time.

But at this stage in the game—SAP said it will release A1S in March—it’s too early to tell whether or not SAP would take the trouble to build out a service and support infrastructure, given the reliability of an outsourcing model.

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