Consolidation in the enterprise resource planning software industry has companies on edge as they consider the impact on their IT investments and business operations.

Optimizing resource management has emerged as a primary objective -- some might say an overriding obsession -- of the 21st-century corporation. And for most organizations, enterprise resource planning (ERP) software is critical to achieving that goal. Without a comprehensive system in place to monitor and integrate a broad range of functions -- from finance to human resources to supply chain management -- a company essentially is stranded in the Dark Ages. Most businesses rely on their ERP system to guide strategic decision-making and provide the insights required to navigate today's global economy. And some view this software as essential to their quest to become integrated, real-time, digital organizations.

But the dream of a single system managing resource allocations across the company may turn into a nightmare as rapid consolidation in the enterprise software industry confronts companies with an urgent question: What happens if your ERP vendor is swallowed up by a competitor or goes out of business?

Although Oracle's proposed takeover of PeopleSoft has grabbed the bulk of the headlines, a host of ERP software providers -- including Geac, Lawson Software, Microsoft Business Solutions, Epicor Software and Mapics -- have embarked on major acquisition campaigns over the last few years. And that may be just the beginning. "We're entering a period of rapid change in the enterprise applications space," says Jim Holincheck, research director at Gartner Inc. in Chicago. "A lot of organizations with large investments in ERP are justifiably concerned about how industry changes could impact their IT investments and their business."

CFOs have legitimate cause for concern. If your ERP provider is acquired by another vendor, future versions of the software your company relies on may be radically different from your current system and may no longer meet your needs. Or, worse, the acquirer may simply discontinue the product you use.

Finance executives must pay close attention to the ERP marketplace's dynamics. Ongoing turbulence in that market makes it more difficult to "build a business plan that's able to accommodate change," says David Link, vice president of The Cedar Group, a Baltimore-based consulting and professional services firm. "Organizations may have to reorient and reshape their [resource planning] approach on the fly."

Big Fish, Little Fish

Any major software investment is something of a gamble, even for companies that perform thorough due diligence and an exhaustive ROI analysis. But ERP systems ratchet up the stakes in a big way. It's not unusual for an implementation to take 12 to 18 months, cost tens of millions of dollars, and leave a trail of headaches and challenges in its wake. Once they have crossed that terrain, few companies want to consider doing so again. "There's a very high ratio between implementation cost and staying with a system," explains Edward Hansen, partner in the technology practice group at New York City law firm Shaw Pittman LLP. "Because organizations pay many times the price of the software to get everything up and running, they're not eager or willing to jump from one product to another."

That's certainly true of The Dow Chemical Co., a global provider of plastic and agricultural products and services based in Midland, Mich. The company uses an SAP ERP system to manage its financials and operations, and a PeopleSoft tool to manage its human resources. It also has an Oracle database in place to process an assortment of enterprise data. Last year, when Oracle announced its intention to buy rival PeopleSoft, Jon R. Walker, global leader of human resource information technology at Dow, initially dismissed the potential deal as irrelevant to his company. But when Oracle CEO Larry Ellison started to talk about discontinuing the PeopleSoft product line if the merger succeeds, Walker's anxiety level began to rise.

"It's not about the brand or technology; it's about business drivers," Walker says. "Potential mergers and industry consolidation create uncertainty, and that can make buying decisions more difficult." In Dow's case, "an Oracle acquisition could mean that we're forced to stick with the existing functionality of PeopleSoft and lag behind -- or spend millions more switching," he notes.

More and more corporate executives are echoing Walker's concerns. Some government leaders are upset, too. The state of Connecticut, for example, implemented a new PeopleSoft HR and financials package last year. Oracle's announcement of its takeover plan for that vendor came just as the state had the software up and running. Nancy Wyman, Connecticut's comptroller, worries that the nearly $100 million the state has spent on the project could go down the drain.

Not surprisingly, Ellison argues that enterprise software industry mergers are inevitable and beneficial. He's battling a Department of Justice lawsuit in his drive to see the PeopleSoft deal through. "All industries begin with lots and lots of little start-ups, and then they go through a basic consolidation phase," he noted at his company's OracleWorld conference in September. "There will be a smaller number of very large technology providers that ... will do a much better job."

That prediction seems on-target. ERP software is maturing, and leading-edge innovation is no longer a top priority for most vendors. Instead, they are focusing on developing stable, comprehensive, tightly integrated product suites. "Many acquisitions have to do with purchasing specific features and expanding the overall functionality of the product," observes Tim Wright, chief technology officer and CIO with Geac, the Markham, Ontario-based enterprise software provider.

Holincheck is unperturbed by the spectacle of large ERP providers gobbling up smaller best-of-breed vendors. Like Ellison, he views that process as a natural stage in the enterprise software industry's evolution. And the future is not entirely bleak for companies that provide specialized functionality. "There will always be niche applications that ERP suites do not address, or do not address well," he explains.

When an ERP vendor takes over a best-of-breed provider, it usually integrates functionality from the acquisition's product into its own software over an extended period, and its customers reap the benefits of that improvement. However, when one large enterprise software provider purchases another, end users of the acquired company's product may face considerable disruption and expense, even if that product continues to be marketed. They may need to move to a more advanced technology platform, upgrading their hardware, software and operating systems along the way.

At the same time, some organizations whose enterprise software vendor has been acquired by another ERP compa-ny report that they have benefited from that change. Aero-Electric Connector Inc., a Torrance, Calif.-based manufacturer of electrical connectors, implemented a SyteLine ERP suite in 1995. When Mapics Inc. purchased SyteLine in 2003, Mark Edwards, Aero-Electric's CIO, worried about the impact of the deal on his company's IT assets. But a meeting with Mapics executives set his mind at ease. "The financial strength of Mapics along with the company's vision made me feel confident that we were on the right technology path," he reports.

Traversing the Minefield

How can companies navigate the rapidly changing enterprise software market? According to Holincheck, organizations that have already implemented ERP software from a vendor that's an acquisition target should probably just sit tight. That advice is also good for companies that find themselves in the middle of an implementation when their ERP provider is acquired by another. At that point, switching to another vendor's product would almost certainly be cost prohibitive. Plus, the changeover would delay the company's access to the benefits that ERP systems deliver.

Organizations that are considering an ERP software initiative should conduct thorough due diligence before selecting a provider. Eliminating all risk is impossible, but a careful investigation of the vendor's references helps companies maximize their chances of a successful purchase. "It is important to find a vendor that is a good match [and] develop a solid partnership," says Deborah Schmidt, Westchester, Ill.-based vice president of SAP America.

Finance can play a key role in the due diligence process. "The financial viability and stability of a vendor is a key issue," says Edward Jensen, an Atlanta-based partner in Accenture's human performance service line. The vendor's annual reports as well as evaluations from credit reporting services such as D&B are helpful resources. Finance executives should also talk to consultants working on the front lines of ERP implementations, according to Shaw Pittman's Hansen. These professionals can offer key insights into ERP providers' business challenges -- information that's especially useful for companies that are considering smaller vendors with less visible profiles.

Savvy companies spend a great deal of time structuring their ERP software purchase contract, Hansen adds. "One thing that many organizations do not understand is that legal and business issues are deeply intertwined," he notes. "They make a deal based on their business needs and then examine the legal aspects. In reality, they need to look at both at the same time."

Equally important, companies should negotiate a maintenance agreement before signing on the dotted line, Hansen advises. This document should specify a period of time during which the vendor will provide maintenance in exchange for a fee. It should also stipulate that the vendor will provide any upgrades that are necessary to keep the software current with generally accepted industry practices. And it should provide an easy and predictable expansion and contraction path so that the software purchaser can modify its IT environment as its business needs change, he says.

Holincheck notes that organizations can leverage business process outsourcing to mitigate technology investment risks. By delegating carefully selected functions to third-party service providers that have invested heavily in enterprise software capabilities, companies can reap the benefits of ERP systems while steering clear of the many headaches and problems associated with this technology.

Application service providers (ASPs) -- third-party vendors that manage and distribute software to customers across a wide-area network -- may appear attractive at first glance, and a business might have valid reasons for using them, Holincheck notes. But the benefits these providers offer can't match those of outsourcing, he says, because an ASP customer must commit to a particular technology path. "Whether the application resides within a company or outside it, the organization must choose an application," he explains.

The Cedar Group's Link says that the best approach is to develop a long-term technology acquisition strategy. It should be based on the organization's business processes and goals rather than on the features included in ERP products' latest releases. "It's important to develop a technology plan that accommodates change and build an organization that's able to adapt," he advises.

Many observers believe that the ERP software market's rapid consolidation will continue for the next few years. In business, as in life, there are no guarantees that change will be for the better. But CFOs can plan to meet it head-on. "The key," says Link, "is to make good decisions, be prepared -- and keep your options open."

How To Navigate the New ERP Market

  • Think drivers, not vendors. It's never wise to purchase an enterprise software system based only on a brand name, even if the vendor you choose is the largest and most stable player in the market. Going with a low-cost enterprise resource planning (ERP) product is risky too, because it may be unable to supply the functionality your company needs, and the vendor may vanish in the rapidly consolidating market. Base your purchase decision on your organization's business drivers and strategies.
  • Conduct thorough due diligence. Evaluate the financial condition of your potential ERP software providers. Those that lack cash are more likely to go out of business or be acquired by another vendor. You should also check vendors' customer references, talk to consultants who work with each provider, and monitor professional and user group discussions, online and offline.
  • Negotiate a solid maintenance agreement. A maintenance contract that covers upgrades, fixes and fees ensures that the ERP software buyer's short-term needs will continue to be met even if its provider is acquired. "The benefit of having an agreement in place up front is that the acquirer has to live by the terms of the contract," says Edward Hansen, a partner in the technology practice group at New York City law firm Shaw Pittman LLP.
  • Emphasize connectivity. Thanks to the Web, extensible markup language (XML), Web services and other integration technologies, connecting disparate systems isn't the nightmare it once was. However, it's still a good idea to ensure that your ERP tool can easily integrate with a broad range of systems. That way, if your vendor goes out of business or is acquired, your company won't be stuck with inaccessible data or the need to buy cost-prohibitive upgrades, notes David Link, vice president of The Cedar Group, a consulting and professional services firm in Baltimore.
  • Consider outsourcing. If the ERP marketplace is too turbulent for your liking, or you doubt the viability of your vendor, outsourcing is an option. It may require significant organizational change, but "it eliminates the need to worry about the underlying technology," points out Gartner Inc. research director Jim Holincheck.