Microsoft, SAP say they considered merging

As part of its bid for a foothold in the enterprise applications market, Microsoft initiated merger discussions late last year with enterprise resource planning leader SAP. The talks ended several months ago after Microsoft decided the deal and the post-union integration would be too risky.

As part of its bid for a foothold in the enterprise applications market, Microsoft initiated merger discussions late last year with enterprise resource planning (ERP) leader SAP. The talks ended several months ago after Microsoft decided the deal and the post-union integration would be too risky.

The two companies disclosed their talks Monday as trial commenced on U.S. Department of Justice’s lawsuit to block Oracle’s proposed acquisition of PeopleSoft. The Justice Department’s case centers on its argument that a PeopleSoft/Oracle combination would adversely consolidate the high-end ERP market, which the Justice Department sees as including only SAP, PeopleSoft and Oracle. Oracle’s counter-argument is that the ERP market is a highly fragmented one, in which the industry’s leaders are under constant pressure from new entrants, like Microsoft.

Microsoft and SAP traditionally do not disclose information about merger or acquisition discussions. The companies said they chose to comment this time because of the likelihood news of their discussions would emerge during the Oracle trial, which is taking place in federal court in San Francisco. Both sides plan to call Microsoft executives as witnesses.

SAP and Microsoft said in written statements that they have no intention of reviving their merger talks.

Both sides cast Microsoft as the suitor. SAP said Microsoft raised the idea of a merger during discussions about a joint development partnership around Web services. While idea of combining the two companies fell apart, the joint-development talks led to an agreement on plans for interoperability between Microsoft’s .Net platform and SAP’s NetWeaver. That agreement was announced last month.

Microsoft began edging into the ERP market several years ago by purchasing Great Plains Software and Navision, which it has combined to form a unit called Microsoft Business Solutions. For now, that group focuses on selling to small and medium-sized businesses. SAP targets smaller companies, but the bulk of its business is from large organizations buying complex systems for accounting, sales and human resources management.

Gartner research director Yvonne Genovese said that the news Microsoft considered buying SAP isn’t surprising, considering the stalled state of the company’s own MBS group. At a Gartner conference in March, Microsoft Chairman and Chief Software Architect Bill Gates responded to a question about the enterprise software market’s future with positive comments about SAP’s prospects – and without a word about MBS, Genovese said.

“It was clear that there was something there that was going on,” she said.

But Genovese thinks the companies’ customers are better off with the arrangement now in place, with the vendors remaining independent but pledging cooperation. A merger would have faced intense antitrust scrutiny from the Justice Department, she said, and been fraught with problems as Microsoft attained the leadership position in a market it’s still struggling to understand.

Microsoft’s announcement last week that CEO Steve Ballmer will directly oversee MBS marked the first time since the group’s creation that Microsoft has treated MBS as a core part of its overall corporate strategy, Genovese said.

“Enterprise applications is a very different type of business than Microsoft has been in in the past,” she said. “It’s a services environment. You have to go in and understand the business model of the customer. Microsoft has always had a one-step-removed model.”

With more than $56 billion in cash on hand at the end of its last quarter, Microsoft has faced pressure from investors to buy its way into higher-growth markets. In the first nine months of Microsoft’s 2004 fiscal year, which ends June 30, Microsoft generated revenue of $27.5 billion, but just $471 million came from its MBS group.