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Microsoft Looms

The Gathering Storm. Microsoft's recent analyst day provides us with a good excuse to initiate coverage of Microsoft as a serious enterprise applications vendor.

We can imagine two, diametrically opposed reactions. One. "What took you so long? Microsoft has announced its intentions. It's committing huge amounts of capital. It is already a major player". And two. "Yawn. Microsoft is just Great Plains + Solomon + Navision + Damgaard + wind. None of those companies have been major players. And Microsoft's saying it doesn't make it so."

The first position is held by many financial analysts. And the second is the prevailing view (we believe) among ERP company executives.

We've been sympathetic to the second view, so far. But we're now beginning to see how Microsoft can exploit some fissures in the market that the ERP players don't want to admit exist.

We think the subject deserves some attention, in any case, so we're devoting three Short Takes to it. In this, the first one, we explain why the ERP executives aren't worried yet—and why they should be.

What, Me Worry? To many financial analysts, the mid-market, where Microsoft plans to play and where all the major ERP players already play (more or less) is a single, small territory, and they are already assigning market share to Microsoft in their models.

But to the ERP executives, the mid-market is a vast continent. If they're all playing in the far Northeast, Microsoft has landed somewhere down in Mexico. Before we need to worry about them, the executives think, Microsoft needs to make its own colony viable, then cross deserts and the broad Mississippi.

Let's say they're right. (They don't have to be; remember, the now-defunct minicomputer manufacturers weren't too worried about the PC, said it would be decades before they collided.) And let's look at the territory they say Microsoft has colonized.

Microsoft Territory. Mid-market ERP software can be segmented along five dimensions: the spectrum of functionality provided, the complexity of company supported, the geographies covered, the industries where special functionality has been provided, and the channel.

Along all of these dimensions, the Microsoft products have taken segments that have very little overlap with the ERP players.

Functionality/geography/company structure. Great Plains and Solomon are American accounting packages at heart, designed primarily for companies with a simple company structure. They have good sales and purchasing and a little bit of inventory control, but not much in manufacturing.

With that functionality profile, there are lots of places where they don't play. Go to Europe, Great Plains or Solomon don't work. Make or distribute stuff in serious amounts, you need good manufacturing, planning, and inventory control; again, neither Great Plains nor Solomon are good candidates.

Navision and Damgaard do work in Europe, and they have better inventory control and good interfaces. But they don't necessarily support American financials or sales processes.

All good products, no question, but in America, GP/S are best suited to small, non-manufacturing businesses, branch sales offices, or some service businesses, and severely limited when a user makes things, distributes things, or has a complex business structure. In Europe, with N/D, there is a similar level of limitation.

Industry. Given the functionality, it has historically made sense for Solomon and Great Plains to target business areas that the typical ERP company rarely touches. Think small consulting companies (we do), NBA teams, plumbing supply distributors, or commodity trading companies. Think doctors' offices, general contractors, or franchisers. Think quarries, stock jobbers, or marinas. Think small software companies and independent insurance agents. In Europe, add in repair depots, branch distribution centers, and custom manufacturing.

Many of these businesses have certain quite special needs. A powdered milk trading company we knew that bought Navision needed to work with total landed cost. The NBA teams use Great Plains partly because the state tax for the players is very complicated. Navision and Great Plains don't necessarily start out meeting these needs, but they can be easily and cheaply customized by the channel partners, who will then support the customization.

By contrast, the more highly integrated and more complex ERP packages are harder to turn to these specialized purposes, and because the channel partners are the Big 5 (3?), special-purpose applications are more expensive to build and maintain. This difference, mind you, is as much in the channel as it is in the software.

Channel. The Great Plains/Solomon channel is uniquely suited to the functionality and the target audience, but may turn out to be a serious barrier if Microsoft wants to move up the food chain.

The channel is enormous--30,000 partners worldwide. And it is the only way of buying the software; Microsoft doesn't sell direct.

It is, of course, the same channel at heart that sells and installs the other Microsoft products. This makes sense. The doctor's office, the rare book dealer, or the producers of syndicated radio shows want to buy from the same guy who sells and maintains their NT network, somebody who sets it up, makes it run, and comes by once a week to troubleshoot. I always call this guy Micky, in memory of one of them, who was a September 11 casualty.

It's important to understand that a lot of Microsoft's projected margin is gained at the expense of Micky. The Micky I knew always ran his little company on a shoestring, working long hours himself and paying his friends too little as well. He would count the hours till his next check came from the client. (Exactly like the companies he was serving.) Micky isn't exactly Accenture.

But as long as Micky doesn't have the skills that Accenture has, the Microsoft suite is never likely to break out from the doctor's office. Micky can put the software in all right, and he can get the system to create GL transactions, but he isn't necessarily going to have much insight into how the company ought to be reporting.

The more complex the requirements, the more judgement required in setting up the software, the more the internals of the software need to be exploited to get benefit, the harder it is for the Mickys of this world.

The past is prologue. None of this is new. Great Plains et al. have never had either the functionality or the channel to compete effectively in the areas that are core for the ERP vendors.

In the past, they could and did nibble away at JD Edwards (and Lawson and QAD), picking off a distributor here or a small engineering/construction company there. But over the long run, this is a self-destructive strategy. To win deals where the fit is poor, you have such a high cost of sales, and later, to keep the customer happy, you have such high maintenance costs, that you simply can't mount a sustained campaign. This is what happened to JD Edwards when it tried to compete with SAP. And historically, Great Plains has known this and has given into temptation only tactically.

Even now, with Microsoft's marketing prowess, there is no reason in the short run why anything should change. Great Plains (or Damgaard or Navision or Solomon) can simply roll up the stone quarries and the union offices, where the only competition is the spreadsheet and Quicken and Peachtree. Why should they move into a more difficult market while there's still low-hanging fruit?

To move into the ERP core areas, they'd have to improve the fit. And every software executive knows that it's really hard to develop functionality in the areas where the ERP software is strong. Even if Microsoft does spend $2 billion on development, they'll have to spend the $2 billion extremely well, or it will be a waste. And Microsoft has never shown that it's good at spending money efficiently on software development, especially when it underestimates the difficulty of the space.

Remember, they can't just develop ERP-level software that is comparable to the competitor's. The competitor's software is already somewhere inside many, if not most mid-market companies where they would be competing. Once you have an ERP system in anywhere at a company, you need a crowbar to get it out. So once Microsoft goes up-market, they have to build the crowbar; they can't just build a comparable system. And that's quite a slog.

Is Microsoft Rational? Unfortunately, Microsoft thinks it has the crowbar. It's .NET.

Microsoft hopes to see a new .NET product rise like the Phoenix from the ashes of Damgaard, Navision, Great Plains, and Solomon. This product will magically connect to any other enterprise application through .NET. With that product, Microsoft thinks it will have a technical edge, a reason to replace SAP.

I don't agree, but what I think doesn't matter. The point is this. While Microsoft is trying to bring the perfect .NET product to the market, it will compete aggressively on price.

And, unfortunately for the ERP vendors, price is an area where they are vulnerable. For better or worse, years and years of gasp-inducing software price tags, long implementation times, high integration costs, and 20-watt benefits have made every executive wary.

The hottest part of the ERP market these days is the extension market, where a vendor sells more software into an existing customer. What if Microsoft starts offering comparable extension functionality, the promise of easy integration in the future, at 1/5 the cost? If customers really believed in ERP software, they wouldn't go for it. But with today's disillusion, at the very least, it will cause what we might delicately call price erosion.

Microsoft is big enough that this kind of strategy could eventually change everybody's underlying expectations about how much these packages cost. Our tiny company expects to pay a few grand-plus and DuPont expects to pay a few tens of millions. All of us could see that shaved in half by the time Microsoft is through. They can afford it (maybe), but their competitors can't.

But if this does happen, don't jump to any simple conclusions about software company revenue. This is pressure on total price. An enterprise application involves costs in three areas: hardware, software, and consulting. It's entirely possible that this pressure may set off a cat fight of Biblical proportions between the Accentures, Suns, and SAPs (or their equivalents among the et al.) In such a fight, you have to bet on the software company. They can take measures to reduce the required investment in hardware and consulting. So they won't take the brunt of the blow.

But lowballing is only the first of two hammers that Microsoft can let fall. We'll talk about the second in the next Short Take, which we call, "All that Cash."

If you missed a recent Short Take, click here for a listing.