Microsoft And SAP Say They Talked Merger Last Year 2Microsoft And SAP Say They Talked Merger Last Year 2

Microsoft and SAP had "preliminary discussions" late last year about a potential merger, the companies revealed Monday.

In a statement, Microsoft said it initiated the talks with the German software company to "explore the possibility" of a merger. The discussions ended a few months ago, Microsoft said, "due to the complexity of the potential transaction and the subsequent integration." There are no intentions of resuming the talks, the company added.

In breaking with its policy of not commenting on potential mergers, Microsoft cited the release of confidential information during the discovery process of the Justice Department's lawsuit to stop Oracle's proposed takeover of PeopleSoft Inc. That trial began Monday in U.S. District Court in San Francisco. Microsoft indicated that Oracle is expected to raise the Microsoft-SAP talks in the courtroom.

SAP confirmed its role in the merger discussions. "SAP, like all publicly help corporations, routinely evaluates potential opportunities to strengthen its leading position in the enterprise software market, and the disclosure made today should be interpreted this way," CEO Henning Kagermann said in a statement.

The negotiations grew out of a joint-development project to support Web services that dates back to January 2003, when Microsoft came out in support of SAP's new NetWeaver software platform for data and application integration. Last month, the companies expanded on that work, disclosing a broad agreement that includes cross licensing of technologies and joint development and marketing. They said they were aligning their "flagship software efforts for the next decade."

SAP is the leading provider of enterprise applications to businesses, and nearly two-thirds of new SAP installations are deployed in Microsoft's Windows environments. Microsoft has been aggressively moving into the applications market through the acquisitions of Great Plains Software in 2001 and Navision in 2002. For the first nine months of fiscal 2004, ended March 31, Microsoft's enterprise applications unit, Microsoft Business Solutions, generated $471 million, a 21% increase over the same period a year earlier.

The Justice Department has challenged Oracle's bid to acquire PeopleSoft on grounds that it would reduce competition and result in higher software prices. Oracle officials are expected to argue in court that Microsoft's growth in the enterprise-applications market is evidence of healthy competition.

Microsoft officials have characterized the company's applications strategy as being focused on small and midsize companies, not large, global companies. However, SAP is widely used in large companies, and a Microsoft-SAP combination would have catapulted Microsoft into a leadership position among that customer segment. "No question--it was clearly an attempt by Microsoft to go up-market in a big way," says Paul Hamerman, an analyst with Forrester Research.

Microsoft would find it much harder to break into the upper tier of the applications market on its own because many large companies have already made their choices among enterprise-resource-planning vendors, Hamerman says. What's more, Microsoft's own portfolio of business applications--consisting of the Axapta, Great Plains, Navision, and Solomon lines--is better-suited for small and midsize companies. "The path for them to get there would be to acquire a big player," Hamerman says.

In its statement, Microsoft made no mention of antitrust concerns in explaining its decision to end merger talks with SAP. However, a combination of that size would likely have drawn regulatory scrutiny. Microsoft employs approximately 55,000 workers and SAP 30,000.

Now that the deal with SAP is off the table, Hamerman expects Microsoft to stick to its midmarket strategy. Just last week, Microsoft took steps to better align its midmarket marketing organization with its business-applications division. Orlando Ayala, senior VP at Microsoft's Worldwide Small and Midmarket Solutions and Partners group, took on the added role of chief operating office of Microsoft Business Solutions. And Doug Burgum, the senior VP in charge of Microsoft Business Solutions, began reporting directly to CEO Steve Ballmer.

Microsoft has begun work on a multiyear development project, code-named Green, to create a suite of business applications build around the company's .Net approach to Web services and tightly integrated with other parts of its product line. However, Microsoft hasn't provided a delivery date for the Green applications, and it could be 2007 or later before they're ready.

A potential merger between Microsoft and SAP might have faced many of the same legal hurdles that Oracle's bid for PeopleSoft has come up against. "While interesting, a Microsoft and SAP combination would have a hard time making it past legal hurdles in the United States and Europe," according to written analysis released Monday by AMR Research. The research company added that "based on interviews we've conducted with other parties, there will likely be other disclosures of merger discussions. These could include one or more 'white knights' that have been approached about possibly merging with PeopleSoft."