Competitors Gnaw at Oracle's Services

Third-party firms are nipping at the software giant's lucrative support services business.
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SAN FRANCISCO -- Third-party support operations have become a bone of contention between bitter software rivals SAP (SAP) - Get Report and Oracle (ORCL) - Get Report.

The issue surfaced earlier this year

when Oracle filed suit against SAP over a unit that supported customers using Oracle's software. Oracle claims the unit, TomorrowNow, exceeded its customers' access rights to Oracle support databases when it downloaded information to which it had no right.

The spat has been embarrassing to the staid German company. By putting the unit on the block, SAP, in effect, is belching up an acquisition whose business ethics gave it indigestion.

The episode also highlights the problems that small, third-party support operations encounter as they vie for maintenance work in an industry dominated by software behemoths Oracle and SAP.

The opportunity for outside support work has grown since Oracle went on an acquisition binge. Displaced executives and independent contractors who once worked for companies such as PeopleSoft, which was acquired by Oracle in 2005, have gone on to establish companies providing support services to customers they once served.

The stakes are high. Support services in the current quarter account for 47% of Oracle's revenue, up from 43% in prior years. Moreover, revenue from support services totaled $8.33 billion in the last fiscal year and is on track to total $10 billion annually. "It's our highest profitability business," Co-President and CFO Safra Catz said at a recent meeting.

Prior to the TomorrowNow controversy, outside support companies seemed to be gaining traction, mostly with customers that struggle to stay afloat. Oracle, though, remains confident these outside suppliers will have little impact on the top line.

Both SAP and Oracle work with big systems integrators that recommend business software to their clients. Oracle does not encourage integrators to provide software support, while SAP allows it. SAP tends to embrace its integrators, Gartner analyst Pat Phelan said.

After the PeopleSoft takeover, SAP saw an opportunity to attract those clients with the acquisition of TomorrowNow.

Oracle has a tolerant, but not cozy, relationship with third-party support firms.Such firms can legally gain access to vendor support databases on behalf of customers that have bought software.

But that relationship can be a sore point when the outside company is an arm of the vendor's primary competitor, because the firm is in a position in which it could illegally reuse the information elsewhere in its business.

Oracle's acquisitions have made it a more obvious opportunity for third-party support rivals than SAP, whose systems have a stigma of being difficult to maintain, said Gartner analyst Pat Phelan.

Oracle's annual support contracts generally charge 22% of the price paid for the software. That's a higher rate than PeopleSoft charged.

Now companies like vendor netCustomer, which originally had contracts with PeopleSoft to provide support worldwide, are putting price pressure on Oracle.

NetCustomer charges between 50% and 75% of what Oracle charges for maintenance, Punita Pandey, the company's CEO, said in September. She added that Oracle customers sometimes took quotes from her company to negotiate better prices from Oracle.

But analysts agree that outside vendors draw an insignificant share of support revenue. "Obviously,

Oracle pushes customers pretty hard to stay on maintenance," said IDC analyst Michael Fauscette. He's skeptical about the value of third-party support, because the vendor is in a better position to troubleshoot problems in its code.

Oracle says it doesn't lose paying customers after an acquisition. "We have no churn to speak of," Catz said. "The renewal rates go up. Customers who went off paying maintenance and support come back" when Oracle buys a software company.

The renewal rate for support customers remains above 95%, Oracle disclosed in early 2007.

Oracle stock was up 17.2% for the year at the end of November, and has been trading higher since. That compares with a year-to-date gain of 7% for the application software sector at the end of November. Oracle is trading at 17 times 2008 earnings.

Outside support providers say they can provide relief to IT departments scrambling to cut budgets as the economy slows in 2008.

"We've got customers who were paying

Oracle seven figures in maintenance," said Seth Ravin, CEO of Rimini Street, a one-year-old company with about 50 customers that is considered a potential buyer for TomorrowNow.

But 50 customers is a drop in Oracle's bucket of 300,000.

Ravin said Rimini Street benefits Oracle in a roundabout way by keeping customers in the Oracle ecosystem. "Oracle worries more about losing customers to another vendor than to us."

But that doesn't mean Oracle fiddles while Rimini burns into its support stream. Oracle has recently gone on "a massive educational reach-out to its customers, highlighting the potential violation in licensing agreements," Global Equities Research analyst Trip Chowdhry wrote in a November note. "Contacts have seen customers canceling their contracts with TomorrowNow and Rimini Street and going back to Oracle."

If the company has begun twisting customers' arms, "I'm not seeing it," Phelan said. However, she said, "Oracle has been rewriting their license and support agreements" to make it more difficult to move to outside support.

"While there's some concern over the sale of the TomorrowNow business unit, customers are still very interested in third-party support for both Oracle and SAP products," Fauscette added.