Creative Destruction

As the ERP industry consolidates and the market matures, what does it mean for the public sector? Plenty.

by , / August 3, 2005
In 1999, Cook County, Ill., the second largest county government in the United States, invested in a new financial management system from software firm J.D. Edwards. Even in the midst of significant financial challenges, County Board of Commissioners President John Stroger Jr. supported the enterprise resource planning (ERP) system project because it was an investment in long-term government efficiency, as did county CFO Tom Glaser. "We felt that an ERP system provided a platform to modernize the way we did business and we were getting a stable partner in J.D. Edwards," Glaser said.

Within a few years, the new system's future was in question when PeopleSoft acquired J.D. Edwards, which like other ERP companies, implicitly promised that the ERP system was "obsolescence-proof" as long as Cook County continued with upgrades. Then, just as the county was determining how to proceed with its upgrade, more turmoil ensued when Oracle acquired PeopleSoft. "Today we are deciding whether to make incremental investments into the system we have, whether a migration to Oracle is affordable or whether we go with an entirely new strategy," Glaser said.

Cook County isn't alone in its desire to modernize business processes and systems. For the past decade, governments have embraced modern technology and Internet computing, and transformed how they conduct business. ERP systems have served as a key component of public-sector transformation strategies. These systems deliver finance, human resources, payroll, procurement and other modules typically manufactured by a single software company, such as AMS, Lawson, Oracle and SAP.

Such systems are attractive to governments because they consolidate data from diverse business processes into a single information repository; deliver best practices and permit re-engineering of business processes for greater efficiency; and enhance customer/citizen service through Internet-based transaction processes. These features have made ERP systems so promising that there is now a $100 billion software and services industry worldwide -- and it's projected to grow steadily through 2008, according to IDC.

Although the ERP industry continues to grow, the wisdom of embarking on an enterprise system project is the subject of intense debate. There are many well publicized failures across leading ERP software products and industries, and although failures aren't as pervasive as they once were, it's not hard to find projects still struggling to go live. The ERP industry's entire landscape has also been shaken by mergers and acquisitions impacting government customers.

Economic historian Joseph Schumpeter once described capitalism as a "process of creative destruction." In his book, Capitalism, Socialism and Democracy, Schumpeter suggests, "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." Oracle's acquisition of PeopleSoft has served as the best example of creative destruction in the ERP industry. PeopleSoft, after all, was a financially strong company with a loyal customer base and a reputation for keeping its products at technology's forefront. The demise of PeopleSoft as a company raised anxiety levels among vendors and customers alike, and had everyone asking, "Is there any ERP software product that can safely weather the storm of industry consolidation?"

Today governments struggle over whether to invest further in the products they already own, purchase another product line altogether, acquire additional modules from niche vendors to cobble together a system through a best-of-breed strategy, or live with their legacy system until the dust settles. Sonoma County, Calif., for example, is deciding how best to modernize its current system. A combination of turmoil in the ERP industry and the difficult experiences of several other counties have Information Services Director Mark Walsh wondering, "Should I really put my eggs in one basket by partnering with a single ERP software vendor for all of the county's application needs?"

Understanding the ERP Market
There are three major elements to understanding the current public-sector ERP market: The type of vendors and product choices available to government; the level of maturation and consolidation now characterizing the industry; and finally, to understand how product lines will change in the future, it is useful to understand how they have evolved to date.

Vendors and Products
The public sector is served by two basic types of vendors and products, which we will call Tier I and Tier II. Tier I is distinguished by superior functionality, advanced technologies and service to various vertical industries. Tier II provides basic functionality for back-office operations but does not match Tier I on product breadth and technology. Also, Tier II firms tend to focus on specific vertical markets such as public sector, nonprofits and utilities. By contrast, Tier I firms serve many industries, and as a result, claim to embed cross-industry best practices into their product lines.

From a government customer standpoint, one of the most important differences between Tier I and Tier II is cost, which can be substantial, and the gap has led to a clustering of target markets for each tier. After examining the ERP purchasing decisions of more than 300 government organizations, our analysis shows that the break point between the Tier I and Tier II markets appears to be at an annual operating budget of approximately $175 million to $200 million. Governments at this level of operating budget are about equally likely to select Tier I as Tier II. At levels above or below this range, the market tends to separate rapidly.

Maturity and Consolidation
ERP is becoming a mature technology, having its roots in the material requirements planning (MRP) software products that emerged in the 1970s. MRP had since evolved into ERP by adding capabilities outside of materials management. The demand for such products that linked financial and nonfinancial functions attracted several new entrants into the market. As industries and markets mature, however, they undergo a consolidation process. When a market is immature, a large number of firms may perceive opportunity and enter the market, just as the emergence of the ERP market saw the entry of companies such as PeopleSoft, Oracle, J.D. Edwards and Lawson. As time goes on, the market identifies the strongest firms and rewards them with more customers. Eventually the weaker firms are victims of creative destruction when they cannot attract enough customers to maintain viability, and drop out of the market or are acquired by stronger firms.

This basic "survival of the fittest" dynamic fits the ERP industry well, with a few key caveats. ERP software sales are not one-time transactions -- they are typically the beginning of an ongoing relationship through the maintenance and support agreement, as well as opportunities for in-selling of new modules to the existing customer base. As the market matures, the weaker don't necessarily disappear -- they may become the acquisition target of a stronger firm attracted to their maintenance revenue. The acquiring firm may migrate the captured customers over to its own products or to a combined product. Oracle, for example, announced the intention of eventually converting PeopleSoft customers over to a combined Oracle-PeopleSoft ERP product dubbed "Fusion." The acquiring firm may also be content to simply hold on to its prey and let its products run their normal life cycle.

The consolidation process to date has only occurred within the Tier I and Tier II markets, but not between them. This is due to the stark differences between the two tiers -- especially in terms of technology -- and incompatibility of the demands of their respective customer bases.

Consolidation clearly entails risk for customers since fewer vendors may mean less competition and anti-competitive practices, such as price signaling -- when, in a market with few vendors, a leading vendor sets a price and other vendors price similarly with a tacit understanding that no vendor will move to undercut the others. In a worst-case scenario, an acquiring vendor may let an acquired product stagnate without providing a clear upgrade path to a new product, forcing customers to purchase from another software company. Consolidation may also mean a change in strategy and direction for the firms involved -- something the customer may not agree with.

Public-sector ERP customers expressed varying degrees of concern related to industry consolidation risks. Some executives who have already implemented ERP felt that, while consolidation complicates long-term systems planning, it won't alter their short-term plans to further integrate ERP into their operations. Others still considering whether single-vendor ERP should replace legacy systems, especially mid-size governments, saw consolidation as an opportunity to seriously consider rapidly advancing Tier II products, which may have previously escaped notice. Still others thinking about replacing legacy systems with ERP felt as if they were in limbo since all of their choices seemed to occur in an extremely uncertain environment.

Evolution of Products
Market maturity has also brought product evolution. The largest vendors invested billions of dollars in their products through direct R&D budgets and by bolting select modules of acquired software to their own solution footprint. While ERP has traditionally been viewed in terms of back-office applications such as accounting, purchasing, human resources and payroll, it has since evolved to take on a much broader role. This expanded reach can be categorized as "extended ERP" or "beyond ERP" solutions.

Extended ERP -- The most visible indicator of ERP's expanded footprint is extended ERP, where software firms offer other online transaction processing (OLTP) applications such as work orders, inventory and CRM. This is called extended OLTP ERP. Some have even extended into analytical applications such as data warehousing and business intelligence. This is called extended analytical ERP.

Beyond ERP -- Extended ERP is characterized by the central role of data. Data-based applications alone, however, don't constitute a complete technology solution, so some software firms are going beyond these with "total solution integration" and "beyond data" solutions. Total solution Integration means the ERP system can provide a comprehensive solution, including modules not provided directly by the core ERP product. Consequently software firms attempting to provide Total Solution Integration must embrace open architecture, programming industry standards and integration technologies, such as Web services.

ERP software firms must also develop alliances with other companies to deliver software solutions outside their core competencies. Beyond Data solutions do not revolve around the concept of data. Examples of such solutions include computer-based training to provide ongoing training for users, and enterprise content management to capture, store and distribute a variety of content besides conventional data.

ERP firms may offer a variety of solutions across any or all of these categories. They may also use partnerships to deliver solutions. The ultimate strength of an ERP software product depends on the depth and breadth of the total solution it can offer across all of these categories.

Track Record of Public-Sector ERP
ERP can be understood to deliver three basic types of benefits: technical success, business process improvement and improved decision-making. On these counts, ERP has enjoyed a mixed track record. The governments interviewed were very positive about the benefits ERP has delivered and didn't regret the decision to invest in such solutions. They also acknowledged, however, that there were many unfulfilled promises. The traditional measure of ERP project success in the public sector has been technical success -- based on whether the project was implemented on time and on budget. This standard reflects risk inherent in early ERP projects when the software was half-baked, integration was weak and implementation methodologies were immature. Public-sector practitioners indicated that technical success is a challenge that has been met with increasing success.

While being on time and on budget is certainly important, the main motivation for pursuing ERP is to promote business process transformation. Public-sector customers are beginning to recognize the importance of placing the achievement of defined business benefits on par with technical success. In fact, many customers who have already implemented ERP have put support organizations in place to help them more effectively realize the business value. The Unified Port District of San Diego, for instance, had initially gone to a decentralized internal support model after its SAP implementation, but recently changed to a more centralized model to better utilize its internal support organization for ERP optimization activities. The public sector as a whole, however, is still just beginning to more effectively realize process improvement from ERP.

ERP also promised to improve executive-level decision-making by consolidating data into a single silo. While there are spotty examples of governments leveraging ERP technology to improve decision-making, product limitations related to information presentation, dissemination and analysis have left decision-support capabilities weaker than anticipated. Niche Business Intelligence (BI) products such as Business Objects, Cognos and Hyperion have moved quickly to fill this gap and pressured ERP vendors to improve their products in this area.

"After investing millions of dollars to optimize their business processes, many governments are finding that ERP alone can't do the job because public managers also make critical decisions that require information from agency-specific systems," said Scott Dulman, director of Worldwide Government Marketing for Business Objects. "Our software enables organizations to provide users self-service access to timely information from all ERP systems, as well as their agency-specific applications and data warehouses. BI delivers a single source of truth across programs, agencies and departments, and this is an area that ERP systems have struggled with."

ERP as a Transformational Technology
Government transformation is a comprehensive, multi-year approach involving the use of enabling technology to promote a radical improvement in efficiency and effectiveness. Transformation is often achieved through implementation of new business processes, service delivery models and human capital strategies. ERP has features that can enable transformation. Most governments, however, have utilized ERP primarily to consolidate disparate information silos and to upgrade their technology rather than transform operations.

One example of transformational change is the deployment of Web-based processes delivered through ERP. The Hackett Group's 2005 Benchmarking Survey found that the highest-performing world-class organizations were four times more likely to have Web-based self-service in payroll, and one and a half times more likely to have it in the time and attendance area. Employees and their supervisors using self-service capabilities can sharply reduce costs and remove the administrative burden from human resources staff, providing the opportunity for them to serve more value-added roles for the organization, rather than processing data.

Shared services is another transformational initiative increasingly being examined by governments. Its objective is the consolidation of back-office functions, such as accounts payable, payroll and human resources, into focused business units whose only mission is to provide administrative functions as effectively and efficiently as possible.

"ERP systems can enable government business process transformation by making new organization models possible," said Accenture's David Wilson. "Technologies such as workflow, imaging and CRM allow financial management transactions to be processed by a shared service center, rather than duplicating finance units in multiple departments.

"Shared services is an idea on the front burner for many large governments because it can cut costs 20 percent to 30 percent while improving effectiveness, and ERP is a key component for successful shared services," he added.

Market maturation has enhanced the prospects for transformational ERP, and as products have stabilized, ERP's perception as bleeding-edge technology is disappearing. Consolidation also provides the opportunity to take advantage of new technological capabilities. Missoula, Mont., recently saw its mid-market ERP vendor acquired by a larger firm. Rather than retarding product development, the city's ERP vendor offers products from its new parent firm. One example is a reporting tool that let Missoula automate its compliance with the financial reporting regulations of Governmental Accounting Standards Board statement 34. "This tool eliminated the need for costly outside consulting assistance previously required for regulatory compliance," said Brentt Ramharter, Missoula's finance director and treasurer, "achieving a two-year payback period on the city's investment in the software."

Market maturation has impacted the development of an outsourcing services marketplace as consulting firms seek additional revenue sources that can use their ERP expertise. "Outsourcing can remove from government the day-to-day responsibility for performing commoditized technology support or transaction processing tasks," said Milwaukee CIO Randy Gschwind. "In addition to having cost reduction potential, it allows staff to focus on more strategic responsibilities." Milwaukee used an application service provider to outsource hosting and certain maintenance responsibilities for its PeopleSoft system. In addition to achieving a 12 percent reduction in costs over a five-year period, IT staff can now focus on tasks such as implementing additional ERP functionality, adding newer constituent-focused technologies and developing ongoing ERP training for the city's users.

Outsourcing may also serve to reduce some of the risk associated with market consolidation. One government that had not yet implemented ERP stated it was more likely to consider business process outsourcing (BPO) where a contractor could be held to deliver a specified level of service. A BPO arrangement makes the stability of the ERP vendor much less of a concern. In this manner, the government would not have to invest in a multi-year ERP project and could instead contract for specific business outcomes directly with the outsourcing vendor.

Basic Economic Theory
In the wake of consolidation, governments are rightfully concerned about the stability of their mission-critical systems. These systems took millions of dollars to establish, and C-level executives who went out on a limb with their oversight bodies to get funding may wonder whether they will have to walk the plank if the industry consolidates further. Basic economic theory suggests that consolidation promotes efficiency -- up to a point. If consolidation leads to monopoly, then rising prices, minimal product innovation and lax customer standards may result. In today's technology industry, however, there are opportunities for smaller, niche firms to keep larger vendors on their toes. If the ERP industry giants of today are unresponsive to their customers, governments may resort back to custom development, best-of-breed strategies or a combination of the two.
Rowan Miranda Contributing Writer
Shayne C. Kavanagh Contributing Writer