newsmaker Since taking the reins of Germany's SAP last year, Henning Kagermann has hardly had a dull moment.

Kagermann assumed the role of chief executive officer at the world's third-largest software company in May 2003 after sharing the title for five years with SAP co-founder Hasso Plattner. But a month after Plattner moved aside, SAP's largest competitors sought to unite against the company.

First, rivals PeopleSoft and JD Edwards agreed to merge. A few days later Oracle, SAP's top competitor, responded with an unsolicited bid to buy PeopleSoft -- a US$7.7 billion deal that's since been contested by the government as anticompetitive.

The PeopleSoft acquisition bid sent waves through the IT industry and landed Oracle in court. But it also spurred Microsoft to approach SAP about a merger -- a negotiation the companies disclosed during last month's Oracle anti-trust trial. The talks didn't get very far, but their existence underscored just how much this segment of the software industry is in upheaval.

Kagermann recently talked to CNET News.com about his brief courtship with Microsoft, his competitor's anti-trust woes, and why it's so tough to innovate when a company has 20,000 chief information officers to keep happy.

Q: A lot of people were surprised to learn that SAP talked to Microsoft about a merger. How serious were the discussions?
A: They approached us, and we listened, but because there was no deal on the table, I cannot answer if we were serious or not. I think that starts once you have an offer.

What was the deal breaker?
We were exploring what could be the potential benefit (of a merger) to customers. It was stopped in the early phases through exploring the question of whether we can both promise significantly more value to both sets of customers.

Is there something particular right now in the enterprise software business that's driving this apparent merger mania? One of the disclosures coming out of the Oracle anti-trust trial is that (Oracle CEO) Larry Ellison has a long shopping list. It seems that this is now going to be the thing to do for 2004-2005. How do you see the world shaking out?
I think that because of this new architecture that is emerging -- service-oriented architectures around Web services -- that the position and the way companies present their value will change. It's obvious that people question themselves. Companies -- SAP included -- are asking themselves what are the spots of hottest value in the future and how well are they positioned there. I think every company in IT is reassessing its strategic position. I strongly believe this is the driver behind (this acquisition trend).

Is it inevitable then that the enterprise software market is going to be reduced to an even smaller number of key players?
I believe there will be a few large players with a comprehensive offering that enterprises -- especially the larger ones -- will more and more look to because the more we support their core business processes, the more strategic the relationship becomes. It will reduce to a number -- I don't know if it is three, four, five, whatever -- not one, but a few.

I don't think there is space for many mid-size companies because either they become the more complete solution provider, or they stay in a niche and they cannot generate enough revenue to make the jump to the large ones. This middle size, I think, will go out.

Where does all of this leave SAP? Do you need a merger partner?

I think every company in IT is reassessing its strategic position.

We want to be one of the larger ones. We think we have the position. We have the market share, and we have the customer base, which doesn't mean you have to do everything. But we get more and more clients who now have 50, 60, 70 percent of their business running on SAP. It means there's a push for us to complete our enterprise applications.

Speaking of Larry Ellison, what do you think European regulators will do if Oracle wins its case against the US Justice Department?

Page II: Since taking the reins of Germany's SAP last year, Henning Kagermann has hardly had a dull moment. In this interview, he talks about Microsoft's bid to acquire the company, and where the enterprise software market is headed.

I think to some extent they would follow the Department of Justice. This is not an official position of SAP, but just my personal opinion.

One of the big questions in the Oracle-DOJ trial was whether or not Microsoft plans to sell applications software to big global firms and compete head-to-head with SAP, Oracle and PeopleSoft. Considering your recent merger talks, what do you think?
Whatever I heard from (Microsoft) is that they are focusing on the mid-market exclusively. So they never talked about the "up market."

One software company that's getting a lot of attention these days is Salesforce.com, and their big IPO last month looks like a major validation. Are you worried about them and their motto that the traditional enterprise software model is dead?
No, it's not a model that could replace today's model. What Salesforce is doing is they pick a few services which are not strategic and give this in a generic way to some clients. This would never replace customer relationship management; it will never replace a suite.

If over time clients like this model, I think we are prepared to do the same. But it's not, in any case, a threat to our model because who in the world would ever give his entire customer-facing process to somebody else? Nobody.

Why not do what Siebel has done and go after Salesforce now? After all, you're looking for growth, and this appears to be a growing market.
Yeah, but rushing into it without a clear, good value proposition that might be a better one than what Salesforce offers makes no sense. I think we have some time. But I don't see a huge market, otherwise we would do it.

Have you formed a vision for SAP over the next five years that perhaps differs from the vision of previous SAP CEO Hasso Plattner? Or is your position to just keep your head down and continue along the same path?
Last year, we started to define a five-year strategy. You will see us moving to a complete enterprise services architecture, which will be finished in 2007.

Customers are buying more incrementally. It's not the big replacement of information technology infrastructure we used to see.

We are building all our applications based on one open platform. We are separating our applications over time into more stable components that provide services and bring faster innovation to the first-movers in the market. So we're trying to solve this issue of an innovator's dilemma, of serving a big installed base that is more conservative and new customers who want to be leading-edge.

The innovator's dilemma is an interesting one. How do you respond to the criticism that SAP has been slow to innovate in recent years? Is it fair to say SAP followed rather than led some of the recent technology waves, such as customer relationship management and e-commerce?
I think everybody has a different view on this. I think SAP, as viewed from the outside, might be slow because we sometimes enter a market at a point when others are in. But when we enter the market, it's a promise for our clients that we are successful and in for a long, long time. This is part of our value proposition, part of our reputation. SAP cannot enter a market and go out. We cannot, like Siebel, go to Latin America and, when business is not coming, just step out. We can't. This is part of our brand.

Do these technological shifts you describe -- Web services and new architectures -- change who you consider to be the competition?
Web services brings an overlap in the competitive landscape, you are right. Because of Web services, we now have some overlap with IBM. We have a broader overlap with Microsoft than five years ago, that's true. It's not black-and-white any longer.

Do these competitive changes make SAP more vulnerable to attack?
If you are not changing, then you might be vulnerable. But we have been on this track now for already 18 months. Everybody is saying we are leading. Our clients feel we have the right pace. So I feel more than comfortable. For us, it's an opportunity.

What's the big deal about Web services anyway?
People want to leverage their investments. There is no chance to come back with the next killer app, and say, "OK, take everything out." They've invested too much. With enterprise services architecture, SAP can help them leverage, bring total cost of ownership down and bring the flexibility.

This resonates well with our clients, and most important, it's not revolutionary. The client would kill us if we would come with a revolutionary idea. What they want to have is getting their bucks out of the investment, while having a vision for the next year so that they don't miss the trend and they have more competitiveness.

Are the days of the software megadeal gone? Will customers ever regain their appetite for really big software projects that SAP is famous for?
Customers are buying more incrementally. It's not the big replacement of information technology infrastructure we used to see. So I think deal size goes down on average. We have less large deals, but we have more deals. I personally don't believe that we will come back to see old days, but I also believe that we will see the bottom very soon.

Will IT spending bounce back then?
No, IT budgets will not grow. People look at total cost of ownership and they all try to squeeze out and try, if they have 3 percent IT expenses, to bring it down to 2.5 percent -- some bring it down to 2 percent. But, if you look at where really the value is created, it's with the enterprise applications, which is sometimes less than 10 percent (of the IT budget). Therefore what is a commodity today, such as hardware, I think will be cheaper and will go down. There is enough demand for applications, so therefore the amount of application spending will grow (and) therefore the application market will grow.

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