Poison pills and white knights: doing business with an ERP industry in transition.

• Author: Miranda, Rowan A.
• Position: Enterprise resource planning

Industry turmoil resulting from the burst of the tech bubble and the recent merger mania facing some of the largest software firms has left governments anxious about the products they own or were considering purchasing. This period of uncertainty is an opportune time to evaluate ERP industry practices and discuss areas in need of improvement and reform.

More than 60 years ago in Capitalism, Socialism and Democracy, economic historian Joseph Schumpeter described capitalism as a "process of creative destruction." Schumpeter suggests that "situations emerge in the process of creative destruction in which many firms may have to perish that nevertheless would be able to live on vigorously if they could weather a particular storm." (1) The enterprise resource planning (ERP) marketplace is living through its own process of creative destruction. The industry itself is facing sluggish demand for software, which in turn impacts firms that provide implementation services. Software firms are undergoing mergers and acquisitions, while upstart mid-size implementation firms are challenging the dominance of the larger consulting companies. The only thing that seems certain is that the go-go years of the 1990s are gone forever and the future will be painful for buyers and sellers alike. It's not the beginning of the end for ERP, but it is certainly the end of the beginning.

MERGER MANIA

While turmoil is common in the enterprise applications industry, it has reached new heights this year. In the Tier I ERP marketplace--the sector serving large and complex organizations with software for a broad range of financial management and administrative functions--industry analysts began examining the possibility of consolidation among three of the top four linens. On June 2, 2003, PeopleSoft announced the acquisition of J.D. Edwards. (2) Days later Oracle announced its intent to acquire PeopleSoft by end-running management and appealing directly to shareholders with a $5.1 billion initial offer that grew to $6.3 billion a few weeks later. PeopleSoft management immediately resisted the takeover, citing antitrust concerns and unfair practices. PeopleSoft's CEO went so far as to characterize the offer as "atrocious behavior from a company with a history of atrocious behavior." (3) Arguing that consolidation of smaller firms to the technology giants is inevitable, Oracle's CEO boldly stated, "There are a lot of Silicon Valley companies that need to go out of business" and that "best of breed is dead, except for dog shows." (4)

Industry analysts speculated that the Oracle takeover of PeopleSoft could be repelled through a "poison pill"--a provision that empowers the PeopleSoft Board of Directors to issue new shares at a discount when a hostile bidder acquires 20 percent of the common stock. Corporate reformers have argued that management often uses poison pill provisions to protect its own hide at the expense of shareholders. Though Oracle's initial offer was greeted with skepticism, it assumed greater credibility when it was raised by $1.2 billion, increasing the chances of PeopleSoft shareholder support. Some analysts suggested that PeopleSoft could seek a friendly buyer--a "white knight."

Where did all of this jockeying leave J.D. Edwards? What about corporate giant Microsoft--a more recent entrant into the ERP market with intentions to invest billions in product development? What will be the response of the other tech giants--IBM, HP, and Sun Microsystems? In this age of poison pills and white knights, is there any way that customers can protect the stability of their mission critical systems?

No matter how the J.D. Edwards-PeopleSoft-Oracle episode turns out, it has introduced considerable anxiety in the marketplace--certainly for customers and potential customers of the companies involved, but also for nearly anyone associated with the industry. Some industry analysts have suggested that customers defer purchasing software, especially from those players whose product lines might be wiped out, until the industry stabilizes. Others argue that buyers of ERP software should move forward but install aggressive provisions in contracts that penalize software firms if they are acquired.

Consolidation is becoming increasingly common in the broader enterprise applications marketplace. Cognos recently merged with its rival Adaytum in the business intelligence and financial planning applications arena. Geac recently purchased Comshare, which gives Geac additional horsepower in the budgeting and planning part of its product line. Is this consolidation period in the enterprise applications sector healthy for long-ran competition and product quality? Or do recent events foretell a coming age in which applications companies will act like utilities and become the tech monopolies and oligopolies of the future, with powerless customers that face eroding quality, minimal product innovation, and higher costs?

GFOA AS INDUSTRY ANALYST

Since 1997, the Government Finance Officers Association has served as a leading public sector industry analyst organization for state and local governments seeking to procure and implement ERP applications. Exhibit 1 is a list of some of GFOA's clients. Over the past six years, GFOA has been engaged in more than 100 projects and has negotiated software and services contracts totaling nearly $650 million for governments of all types and sizes. Although its role in most engagements is limited to procurement advisory services, governments have retained GFOA to help manage and conduct quality assurance activities during system implementation. These combined experiences in system procurement and implementation provide us with a unique vantage point to examine ERP industry practices in the public sector. (5)

This article discusses the structure and practices that have shaped the ERP industry. We examine where ERP applications sit today in the cycle of innovation, maturation, and commoditization that has characterized many technologies in the past. We also present seven areas that can impact the outcome or value of ERP projects, including a discussion of the associated challenges and suggested action steps for governments.

INDUSTRY STRUCTURE

In the 1970s and 1980s, several large companies such as American Management Systems and KPMG Peat Marwick served the high-end state and local government systems marketplace. Most governments installed these products using a strategy of customization whereby they changed the source code to fit their specific business processes. The City of Chicago, for example, installed a new financial system in 1985 that was so heavily customized that it could not undertake many of the upgrades provided by the software manufacturer. The city finally decided to replace the system (with the assistance of GFOA) with the Oracle product in 2002.

Another GFOA client, Santa Clara County, California, had been relying on technology that was more than 15 years old for key components of its administrative systems. The financial system, while fine for its day, prevented the county from accessing information critical to tactical and strategic decisions. In terms of performance, the system was not meeting the county's expectations for expenditure analysis, outstanding invoice/encumbrance analysis, account posting, budgeting, cost recovery analysis, and program/project tracking. Santa Clara County recently completed the implementation of a new ERP system, relying on SAP's financial management suite and PeopleSoft's HRMS.

The City of Chicago and Santa Clara County situations are not at all unique. Many state and local governments that purchased systems 15 or 20 years ago now find themselves in the same predicament. Their legacy systems are not flexible enough to adopt new business practices, acting as barriers to information integration. The short-term response has been the development of standalone and "best of breed" systems, which has only further fragmented information access within government. Moreover, individuals with expertise in the programming languages of legacy systems are an endangered species. The modern ERP industry arose as a solution to all these issues.

The software firms that had a large market share 15 to 20 years ago fell behind the times--in both their technology standards and product development strategies--and new entrants gained market share in the 1990s by relying on client/server and relational database technologies to deliver entire product suites for a broad range of financial and administrative functions. As the manufacturers of older software products stabilized their revenue streams with services revenue from patching systems for Y2K, many of the newer entrants invested in rewriting their products to accommodate client/server and Internet technologies. The progressive firms recognized early on the importance of the linkage between the Internet and back-office systems such as ERP. Exhibits 2 and 3 provide a snapshot of the enterprise applications industry as it looks today.

Exhibit 3: Stratification of Enterprise Application Firms By Tier In the GFOA book Technology Needs Assessments: Evaluating the Business Case for ERP and Financial Management Systems (2002), a number of factors are identified to differentiate the types of enterprise software products in the public sector. Based on those factors, the authors identify the following four tiers in the marketplace. Tier I--The Industry Leaders. If the vision of an ERP system is to provide software capabilities that permit seamless integration of major processes and functions across the enterprise, no more than a half-dozen firms (the Tier I firms) in the industry today provide solutions for the public sector that fit this vision. The advantages of the Tier I firms are superior product performance and a vision focused on utilizing leading-edge technology. Tier I companies dedicate a considerable portion of revenues to research and...