The Efficient Consolidatoreconomics-files.pomona.edu/.../oraclereport.pdf · Oracle’s Collaboration and Developer Suites Oracle Collaboration Suite is a single, integrated suite

The Efficient Consolidator

Andrew S. McKibben Douglas J. Leavitt Michael Mandelbaum April 20, 2005

Oracle Corporation: The Efficient Consolidator

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Table of Contents

Executive Summary ...................................................................................................... 3

Company Background .................................................................................................. 4

Business Overview ....................................................................................................... 7

Software Business..................................................................................................................7

Services Business ................................................................................................................11

Financial Analysis ....................................................................................................... 14

Competitive Analysis .................................................................................................. 17

Industry..................................................................................................................................17

Internal Rivalry ......................................................................................................................18

Applications ..........................................................................................................................21

Buyer and Supplier Power ...................................................................................................22

Substitutes and Complements ............................................................................................22

Entry.......................................................................................................................................23

PeopleSoft ................................................................................................................... 25

Strategic Outlook ........................................................................................................ 28

Conclusion................................................................................................................... 32

Appendix...................................................................................................................... 33

References................................................................................................................... 34


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Executive Summary Oracle is the second largest enterprise software vendor in the world. Specializing in database

technologies, Oracle has recently diversified its offerings to include technologies complementary

to its database software, namely in infrastructure and application software. This diversification

has been the trend amongst all of its main competitors (IBM, Microsoft, and SAP) and is the

result of market maturation across the software industry.

To succeed in this increasingly competitive environment, we believe that it is imperative for

Oracle to increase investments in the research and development of new and existing

technologies. Oracle needs to maintain the competitive advantage of its database technologies

and increase the quality of its application software if the company hopes to benefit from the

complementary nature of these offerings. Furthermore, the smooth and timely integration of

PeopleSoft’s consumer base is essential and merits additional SG&A expenditures.

We believe that the increasing complexity of current technologies will only exacerbate the costly

and time consuming nature of their installation and deployment. The development and

acquisition of such technologies should be a priority, as it would give Oracle’s products a

potentially significant cost advantage.

In the long run, Oracle should continue its role as a consolidator, specifically targeting smaller

firms with room for operational improvements in markets complementary to their database and

applications business as well as in adjacent markets that are related to Oracle’s area of

expertise; data management.

The successful application of these strategies should strengthen Oracle’s already outstanding

margins and increase revenues in addition to its overall market share.


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Company Background

As the second-largest enterprise software vendor in the world, Oracle provides a diversified

range of products to enterprise customers. Larry Ellison, Robert Miner, Bruce Scott, and Edward

Oates founded System Development Laboratories (SDL) in 1977 to create a database

management system according to the theoretical specifications published by IBM. Shortly

thereafter, in 1979, Oracle introduced Structured Query Language, which defined the basic

syntax that databases used to manage information.

In 1983 the company changed its name to Oracle. At this time, the developers made a critical

decision to create a portable version of Oracle (Version 3) that ran on a variety of different

platforms. By 1985, Oracle claimed the ability to run on more than 30 platforms (it runs on more

than 70 today). This versatility enabled Oracle to leverage and accelerate the growth of

minicomputers and UNIX servers in the 1980s and lead to an increased market share. Oracle

follows a similar and equally successful strategy today, leveraging its portability on Microsoft

Windows NT/2000 and Linux which has allowed it to capture a significant market share on these

more recent platforms.

In addition to multiple platform support, complementary software development, decision support

tools, ANSI standard Structured Query Language, portability across platforms, and connectivity

over standard networks have become characteristic of Oracle. Oracle has also become known

for introducing many innovative technical features to the database as computing and

deployment models changed (from offering the first distributed database to the first Java Virtual

Machine in the core database engine).

Oracle went public in 1986, and within two years had a 36% share of the U.S. PC database

market. During this period, the corporation began diversifying its product line by offering

software for financial management, graphics, and human resource management. Unfortunately,

Oracle also developed a reputation for announcing products that had not yet been developed. It

also had a habit of releasing products that were full of errors or were missing advertised

features. To make matters worse, it was discovered that revenues had been inflated through

such practices as duplicate billings and the inclusion of unconsummated sales.

These factors, coupled with a fiscal loss in 1991, caused Oracle’s stock price to plummet.

Consequently, the company undertook a serious restructuring. Larry Ellison hired Ray Lane who

imposed strict performance standards for the company and streamlined its operations. Oracle7

was launched in 1992, and signaled a new era for Oracle. Within two years it became the


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number one database management software maker and sales for fiscal 1994 hit $2 billion.

Since then Oracle has continued to rise, becoming one of the most dominant software

companies in the world, competing with Microsoft, IBM, and SAP.

In 1999 Oracle bought three niche front-office software specialists and took its Oracle Japan

subsidiary public. In 2000 Oracle partnered with rival Commerce One to provide software and

support for a giant online venture which merged the Web-based procurement exchanges of

General Motors, Ford Motor, and DaimlerChrysler. Later that year, Lane resigned as president

and COO.

In 2001 the company continued to expand its portfolio of business applications, introducing

warehouse, supply chain, and customer relationship management software, as well as software

suites targeted at small businesses. Best known for its namesake database system, the

company recently diversified its offerings across both the infrastructure and applications

software industries. On the infrastructure side, the company’s offerings include an application

server, development tools, business intelligence functionality, systems management tools,

storage management, and collaboration tools. On the applications side, the company provides

an E-Business Suite of products, which can also be sold as individual modules, including

applications such as financial management, supply chain management (SCM), customer

relationship management (CRM), and marketing. However, about 74% of Oracle’s revenues

continue to come from its core software business.

2003 marked the beginning of Oracle's long and heavily contested bid to acquire rival

PeopleSoft. PeopleSoft’s board unanimously rejected the initial all-cash offer of $5.1 billion,

citing the unsolicited bid to be inadequate and antitrust concerns. After bitter negotiations that

included a number of rejected bids, Oracle finally reached an agreement with shareholders to

acquire PeopleSoft for $10.3 billion in December 2004 with the deal closing in January.

Soon after, Oracle reduced its combined workforce by 9%, with former PeopleSoft employees

bearing the brunt of the cuts. However, it has retained the majority of PeopleSoft's development

and support teams, and it has vowed to support PeopleSoft product lines until 2013. Despite

Oracle’s efforts, many question its ability to successfully integrate its notoriously competitive

culture with PeopleSoft’s community oriented mindset. The success of the acquisition will

largely be determined by whether or not Oracle will be able retain PeopleSoft’s customers and

effectively incorporate PeopleSoft’s employees.


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In the midst of its consuming efforts to acquire and integrate PeopleSoft, Oracle has continued

to improve its market position by enhancing its business software product offerings by

introducing new applications as well as updating its existing systems. Oracle launched its

Business Intelligence 10g application in late 2004, moving into the enterprise content

management software market where IBM and Microsoft have already staked out positions.

Oracle is also working to grow its business by moving into new global markets. The company

hopes to gain market share in both India and China by extending its product offerings there.

Currently, more than half of Oracle's sales come from outside the US.

Presently, Oracle generates approximately 79% of its revenues from its software business and

21% from services, including advanced product support, consulting and education. The

company employs over 40,000 people worldwide and has approximately 27,000 in sales and

services. Oracle is headquartered in Redwood City, California.


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Business Overview Oracle is organized into two businesses, software and services, which are further divided into

five operating segments. Software business contains two operating segments: (1) new software

licenses and (2) software license updates and product support. Oracle’s services business is

comprised of three operating segments: (1) consulting, (2) advanced product services, and (3)

education. The software business represented 79%, 76% and 73% of total revenues while the

services business represented 21%, 24% and 27% of total revenues in fiscal 2004, 2003 and

2002, respectively.

Software Business New Software Licenses New software licenses include the licensing of database technology software and applications

software. Oracle’s software platform is based on an internet architecture comprised of

interconnected database servers, application servers, and client computers or devices running

web browsers. This architecture permits end users to access business data and applications

through standard web browsers, while allowing enterprises to manage business information and

applications from centralized locations. Database servers manage the underlying business

information, while application servers run the business applications. These servers are typically

managed by professional information technology managers. In contrast, traditional client/server

computing architectures require that each client computer run and manage its own applications

and also be updated every time an application changes. The integrated, component-based

architecture can be adapted to the specific needs of any industry and is supported on many

different operating systems, including Linux, UNIX and Windows. New software license

revenues represented 35%, 35% and 36% of total revenues in fiscal 2004, 2003 and 2002,

respectively.

Database Technology Oracle’s database technology software provides a platform for developing and deploying

applications on the internet and on corporate intranets. Database technology software products

include database management software, application server software, collaboration software and

development tools that allow users to create, retrieve and modify the various types of data

stored in a computer system. Database technology software is the primary driver of Oracle’s

revenues. New software license revenues from database technology products represented


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82%, 81% and 80% of new software license revenues in fiscal 2004, 2003 and 2002,

respectively.

Oracle Database

The Oracle Database can run applications with a very high degree of scalability

and reliability across multiple computers clustered together. One of the main

advantages of the Oracle Database, and of the new Oracle 10g in particular, is

that it reduces the cost of scalability through its support of lower end computers.

Oracle Database 10g also contains self-diagnosing and self-tuning features, as

well as features that facilitate customers’ ability to build, deploy and manage

internet applications at lower costs. The key features of the Oracle Database

include improved database availability, functionality, enhanced security

capabilities and an integrated infrastructure for building business intelligence

applications.

Oracle Application Server

The Oracle Application Server, a consolidated software platform based on

industry standards, makes it easier for developers to build and deploy web

services, web sites and portals, and web-based applications. The Oracle

Application Server comes with an integrated set of business intelligence software

including Oracle Discoverer, Oracle Reports and Oracle Clickstream.

Oracle’s Collaboration and Developer Suites

Oracle Collaboration Suite is a single, integrated suite that manages email and

voicemail messages, facsimiles, calendaring, file sharing, search and workflow.

The Oracle Collaboration Suite centralizes administration and lowers operating

costs by consolidating email and file servers. Oracle Developer Suite is an

integrated suite of development tools designed to facilitate rapid development of

internet database applications and web services.

Oracle Data Hub

Data hubs serve as repositories for metadata about the enterprise, defining key

business objects such as customers, products, and employees. The Oracle

Customer Data Hub is a packaged solution that enables companies to create a

single enterprise customer database by consolidating customer data from


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heterogeneous systems. After the data is consolidated into the central customer

data store, it can be standardized, cleansed and enriched by use of embedded

functionality and then used by other applications with near-real-time

synchronization.

Applications The Oracle E-Business Suite is built upon unified information architecture. Applications software

includes financials, projects, marketing, sales, order management, procurement, supply chain,

manufacturing, service, and human resources, which can be accessed with standard web

browsers and can be used to automate business processes and provide business intelligence.

New software license revenues from applications software represented 6%, 7% and 7% of total

revenues and 18%, 19% and 20% of new software license revenues in fiscal 2004, 2003 and

2002, respectively.

The Oracle E-Business Suite is designed to optimally function as a part of Oracle’s full

technology stack, including database, application server and developer tools. The E-Business

Suite is an open architecture, providing clients with a high degree of customizability. However,

Oracle’s application suite is generally regarded as being inferior to SAP’s offering, a

disadvantage that has only been exacerbated by the difficulties surrounding the acquisition of

PeopleSoft.

On a constant currency basis, new software license revenues increased in fiscal 2004 primarily

due to higher database technology revenues in all geographic areas, but were offset slightly by

lower application revenues. The higher database technology revenues can be attributed

primarily to the competitive advantage of the Oracle 10g, which has capitalized on its

technological superiority and cost effective nature. These revenues were further bolstered by

the progress Oracle has made in the application server market, where Oracle has been able to

successfully leverage its complementary technologies and services to steal market share from

BEA Systems.

The decrease in application revenues is a result of customer fears over the uncertainties

surrounding the PeopleSoft acquisition, and the superiority of SAP’s offering. Nevertheless, new

software license sales in the United States increased 5% and 1% internationally. The Americas

contributed 62% to the increase in new software license revenues in fiscal 2004, EMEA

contributed 15% and Asia Pacific contributed 23%.


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.

Software License Updates and Product Support Software license updates provide customers with rights to unspecified software product

upgrades, maintenance releases and patches released during the term of the support period,

which is typically one year. Product support includes internet access to technical content, as

well as internet and telephone access to technical support personnel. Product support is

provided by local offices, as well as by four global support centers located around the world.

Software license updates and product support are generally priced as a percentage of the net

new software license fees. Software license updates can be purchased separately from product

support; however, only customers who purchase software license updates can purchase

product support. New software license purchases almost always entail the purchase of software

license updates and product support. A substantial majority of Oracle’s customers renew their

product support contracts annually. Software license updates and product support revenues

represented 44%, 41% and 37% of total revenues in fiscal 2004, 2003 and 2002, respectively.


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Software license updates and product support revenue growth rates are affected by the overall

new software license revenue growth rates, as well as the renewal rate of annual support

contracts by existing customers. The increase in software license updates and product support

revenues in fiscal 2004 is a result of the near complete renewal of the prior year’s subscription

base, and the addition of software license updates and product support revenues associated

with new software license revenues. We expect that these revenues will increase substantially

as support for PeopleSoft’s large customer base is transferred to Oracle. We also expect

associated expenditures for this segment to increase as Oracle works to maintain the quality

support of its newly acquired customer base.

Services Business Consulting Oracle Consulting is designed to support Oracle’s core offerings. This segment consists of

professionals specializing in the design, implementation, deployment, upgrade, and migration

services for Oracle’s database technology and applications software. Consulting revenues

represented 16%, 19% and 21% of total revenues in fiscal 2004, 2003 and 2002, respectively.

The downturn in IT spending has hurt Oracle’s consulting business. This has resulted in

decreased demand for consulting implementation services, and the increased use of lower cost

third parties. In response, Oracle has lowered head count and outsourced its personnel to

reduce costs.


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Advanced Product Services Advanced product services are comprised of Oracle On Demand (formerly Oracle Outsourcing)

and advanced product support services. Oracle On Demand offers services for its products

through three core offerings; E-Business Suite On Demand, Technology On Demand and

Collaboration Suite On Demand. These services are designed to lower client’s information

technology costs and improve their business efficiency, by allowing Oracle to manage

availability, security, performance, change, and problem management of its own software. The

advanced product support services assist customers in configuration and performance analysis,

personalized support and annual on-site technical services. Advanced product services

revenues represented 3%, 2% and 3% of total revenues in fiscal 2004, 2003 and 2002,

respectively.

Like the consulting business segment, advanced product support services revenues have been

hurt by the tighter economy and decreased IT spending. However, the decrease in advanced

product support services revenues was offset by an increase in Oracle On Demand revenues.

The decrease in this segments profit margin was due to investments made in facilities and in

personnel to support the growth of the Oracle On Demand business.


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Financial Analysis General Oracle’s market capitalization has climbed since the company’s inception, spiking during the

internet bubble. The recent decline in Oracle’s market value during the first half of 2004 can be

attributed to the pessimism surrounding the acquisition of PeopleSoft. Many investors see

Oracle as playing a major role in the future consolidation of the software industry, and the

difficulty surrounding the PeopleSoft acquisition was taken as a signal of potential future

difficulties in this area. However, the launch of its new Business Intelligence 10g application in

mid-2004 as well as the completion of the PeopleSoft acquisition seems to have limitedly

restored investor confidence.

However, our Discounted Cash Flow Model (see Appendix) suggests that Oracle is still currently

undervalued. This suggests that, while the two recent developments mentioned above seemed

to have raised investor’s expectations about Oracle’s future profitability, the market as a whole


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stills remains somewhat skeptical given the competitive environment. This also may explain

Oracle’s slightly lower PE ratio compared to its main competitors, with the exception of IBM.

However, on the basis of EV/FCF, excluding IBM, Oracle seems to be doing better than its

peers.

Valuation Oracle IBM Microsoft SAP Industry2 Market

Price/Sales Ratio 6.27 1.59 7.13 4.87 6.11 1.43 Price/Earnings Ratio 22.61 18.73 27.42 27.89 35.57 23.37 Price/Book Ratio 7.67 5.17 5.81 9.68 4.23 2.71 Price/Cash Flow Ratio 20.75 12.01 25.23 27.32 27.36 12.38

On an annual basis, total revenues were up about 9% on an as-reported basis, but up only 1%

excluding gains due to currency fluctuations. On a geographic basis, the Americas were the

most successful driver of license revenue growth on a constant currency basis (19%), followed

by with Asia (4%). Europe (-9%) seems to have been a drag on these gains, yet Oracle’s

management seems confident that the situation in Europe with improve relatively soon.

Profitability Oracle IBM Microsoft SAP Industry2 Market

Gross Profit Margin 77.78% 43.12% 85.88% 70.11% 82.11% 48.41% Pre-Tax Profit Margin 40.21% 11.96% 38.79% 24.30% 26.13% 9.25% Net Profit Margin 27.94% 8.74% 25.98% 17.45% 17.46% 6.00% Return on Equity 34.30% 28.40% 21.20% 34.60% 12.10% 11.40% Return on Assets 22.40% 8.40% 15.40% 20.80% 8.70% 1.90% Return on Invested Capital 33.70% 19.50% 21.20% 34.60% 11.60% 5.50%

Overall margins continue to improve and the company has strong free cash flow. Compared to

its main competitors, Oracle has higher profit margins where it counts, namely it’s Pre-Tax and

Net Profit Margins. Oracle also has a very good ROE, only three tenths lower than its competitor

SAP. A DuPont analysis, preformed in the DCF model below, indicates that Oracle’s high ROE,

while hurt by a total asset turnover ratio of .8, is principally aided by the company’s high Net

Profit Margin. In general it appears that Oracle is doing very well, and that its high profitability

can be attributed to the company’s ability to keep its costs down.

Given the company’s broad product platform, strong competitive position, and outstanding

operating margin Oracle appears to be in a relatively stable financial position. However, Oracle

needs to maintain its growth. The database is viewed as one of the core components in the IT

infrastructure. Since much of Oracle’s revenue comes from the service and support of its

existing database customers, dominance in this sector will be a key determinant of their future

success. However, the database management systems market has matured and annual growth


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rates are minimal. Thus, any growth in market share must come from competitive market share

gains from IBM and Microsoft, which depend on Oracle’s ability to differentiate itself through the

offering of complementary technologies and services.

The PeopleSoft acquisition represents a move in this direction, as Oracle tries to strengthen its

applications offering. Yet, the markets for Oracle’s complementary technologies have essentially

mirrored the maturation and consolidation of the database market, as Microsoft, IBM, and SAP

have strengthened and expanded the breadth of their product offering through acquisitions and

strategic partnerships. Oracle’s solid financial status and large margins will continue to enable

Oracle to make effective strategic acquisitions in these markets.


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Competitive Analysis We are focusing this section on Oracle’s software business, which accounted for 79% of the

company’s revenues in 2004. We have further divided our analysis between database

technologies and applications, as we feel that these two business segments are the most

pertinent to our analysis.

Industry

Database Technology High-performance applications used by enterprise customers require the availability of large

computational resources; including processing power, storage, and bandwidth. Furthermore, the

dependence of day to day operations of such customers on their applications requires them to

have high availability, reliability, and scalability characteristics. Mainframe systems, pioneered

by IBM over thirty years ago, offer these characteristics but do so at a high financial cost to

customers, while also exhibiting little capacity to scale in order to match computing tasks. Thus,

it is not surprising that various alternatives have appeared to deal with these issues. However,

the problems of the mainframe systems have only been addressed with compromise. Basically,

solutions to scalability and high cost came only through the development of increasingly

complex systems that yielded reduced availability, reliability, and upward scalability.

The evolution of many of these alternate technologies over the last 20 years was largely driven

by the central and constantly expanding role played by database systems and software

applications. Until recently, the database vendors had efficiently segmented their end-markets

along their core strengths, minimizing direct competition. Oracle’s position of strength had

traditionally been with customers who required high-end database performance and wanted to

deploy their systems on distributed systems. IBM also provided high-end performance, but

customers typically deployed DB2 on mainframes. Microsoft, in contrast to both, approached the

market from the home user and small or medium business perspectives and required users to

operate their databases on Windows systems.

Starting in the late 1990s, with the increase in IT spending and the subsequent IT spending

drop-off, the roughly articulated customer and vendor segmentation began to undergo rapid

structural change. Annual growth leveled off as the market became saturated. Oracle, IBM, and

Microsoft began to realize that growth opportunities would increasingly be limited to wrestling

away market share from the other two leading database vendors.


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Application Software Software applications, like database management systems, also provide tools essential to any

company’s effective utilization of information technology. The industry is primarily composed of

a number of differentiated, but sometimes overlapping, branches of software applications such

as ERP (enterprise resource planning), CRM (customer relationship management), SCM

(supply-chain management), and procurement. In general, ERP focuses on the administration

and management of manufacturing, human resources, and financial management. CRM is

software that helps an enterprise to organize customer information and enhance customer

interactions, which generally tend to improve a customer’s sales. SCM software allows for more

oversight and coordination of materials, information, and finances as they move throughout the

company, potentially lowering costs. Oracle competes in each of these segments of application

software, which today have a combined market size of approximately $8.9 billion.

Internal Rivalry

The relative maturity of Oracle’s markets means that the increasingly intense competition for

market share is the primary factor influencing Oracle’s choice of business strategy. Oracle

primarily competes in two general markets; database management systems (DMS) and

business software applications. Since the internet bubble burst in 2000, these markets have

been increasingly dominated by a few key players. The market for DMS is mostly divided

between Oracle, IBM, and Microsoft, while SAP and Oracle are the two largest players in the

business applications market.

Database Technology The market for database management systems revolves primarily around price and

functionality. Microsoft’s SQL Server, while not typically viewed as highly as IBM’s and Oracle’s

software, is easier to use and priced to target small to medium sized businesses. IBM and

Oracle traditionally produced higher end, specialized software. Until 2000, each of the three

main vendors tailored their main product offering to target different market segments. However,

as growth of the database market slowed in 2000, it became increasingly clear that the

continuation of sales growth would come primarily from competitive gains in market share. The

logical result has been that Oracle, IBM, and Microsoft have all taken steps to converge their

product and customer focuses to match the change in customer sentiment and individual


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corporate strategies. Oracle and IBM, for instance, have made important strategic decisions to

widen or improve the deployment options offered for their software to other operating systems.

Oracle has increased its focus on the low cost operating system Linux and has also entered into

a strategic alliance with Microsoft to allow applications for Oracle’s products to be written using

Microsoft software. This benefits Microsoft because UNIX and Windows are the two main

operating systems used by enterprise customers and currently, about 39% of new license

revenues come from UNIX-based databases while 38% come from Windows. Microsoft has a

zero percent share of the Unix-based database market, while a 45% share of sales coming

Windows-based sales. Microsoft, leveraging Oracle’s product, benefits from consumers

increased incentive to use its Windows operating system, the cornerstone of business. Oracle

benefits from the increased adaptability of its software to customers using the Windows OS, a

market segment in which it currently only has a 26.5% share.

Given the relative maturity of the market, the database technology development of each of the

three major vendors has mirrored one another. Each vendor has been quick to adopt new XML

support and functionality, and to incorporate business intelligence tools into their product

offering. Yet, important differences between each vendor’s offerings still remain. Microsoft,

despite is ability to leverage its Windows OS, is still unable to offer some of the key

technological advancements found in Oracle’s 10g and IBM’s DB/2. The recent release of

Microsoft’s database Yukon has closed this gap somewhat, and will probably fare better that its

SQL server.

While Microsoft is attempting to raise the quality of its offering, IBM and Oracle also have

important new releases of their core products in an attempt to incorporate the better aspects of

their rivals’ products. In an effort to simplify database administration to better target small and

medium sized customers, the Oracle 10g features reflect an attempt to mirror some of the

automation tools incorporated into the Microsoft’s SQL Server 2000. Microsoft’s former

emphasis on ease of use and IBM’s primary concentration on high end mainframe servers has

put Oracle in a unique position to capitalize on current trends.

Oracle’s initial focus on high performance and scalability through the use of multiple servers,

has given the company a technological head start. Exploiting this advantage, Oracle has been

able to develop a product offering with a higher performance to price ratio than either of its


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competitors. This has given Oracle’s product offering at least a temporary advantage over the

offerings Microsoft and IBM, in both of the key market segments.

Flexibility provided by the Real Application Clusters (RAC) architecture allows servers to be

added as needed to improve overall system capacity. Due to previous problems with scalability,

customers were often forced to purchase large and costly servers that exceeded their capacity

requirements. This is an important advantage for Oracle, since it enables its customers to

purchase only hardware capacity deemed necessary. IBM has also successfully addressed the

issue of performance and scalability with its Parallel-Sysplex architecture. However, the

complexity of the architecture makes it difficult and costly to maintain in contrast to the relatively

simple, yet technologically advanced, RAC.

Furthermore, management features provided with Oracle 10g and RAC provide a similar

advantage in that they allow customers more control over the provisioning of their servers

resources, which will enable them to customize Oracle software to more closely match their

computing needs. However, despite the advantages of Oracle’s 10g and RAC, the advanced

software features tend to dominate a processor’s resources. Yet, considering the high frequency

of developments in the speed and performance of processors, the reliance of Oracle’s RAC on

processor resources is not such a bad trade off after all.

The other result of the market’s maturation has been increased price competition amongst

Oracle, IBM, and Microsoft. In terms of pricing strategies, all three vendors have their plans

competing around a relatively simple per-processor license model. Moreover, each company

now offers heavily reduced pricing plans for the small to medium sized customers (SMB), a

segment that Microsoft was particularly well-positioned to capitalize upon. In February 2004,

Oracle dropped its lowest pricing tier by $1,000 in order to match Microsoft’s pricing. This

offering may match Microsoft in price, yet it far exceeds the SQL Server in performance. Oracle

further altered its standard edition pricing to include the new RAC option for free for up to four

clustered processors.

Competition is clearly becoming more intense between Oracle, IBM, and Microsoft. In addition

to price and performance competition, each firm is making an effort to leverage their other

products to promote the use of their database technologies and vice versa. This explains the

strategic alliance between Oracle and Microsoft discussed above. It also explains Oracle’s

aggressive behavior in the market for software applications. This same strategy was most


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effectively used by Microsoft, who was able to leverage the wide use of its Windows OS by

automatically incorporating its other software (Internet Explorer). Oracle can use its presence in

the database market, to encourage the adoption of its software application, thereby increasing

its market share in the area.

Despite the apparent advantages of Oracle’s product offering, the underperformance and

problems associated with past product offerings have somewhat damaged Oracle’s credibility.

While this was less of a problem in the past, market maturation and the resulting increase in

competition have made Oracle’s image a much more serious issue. For Oracle to fully realize

the competitive advantages of its products, a concerted effort to rebuild its image may be

necessary.

Applications The software applications industry, with a higher concentration of smaller firms, has been hit

harder by the downturn in IT spending that the database industry. Oracle’s product orientation

and size have not only allowed the company to weather the storm, but have also made it easier

for Oracle to gain market share in the current climate. Oracle has leveraged its size and the

revenues generated from its database technologies to acquire a number of its rivals, notably

PeopleSoft in late 2004.

This industry was divided early between companies offering specialized software focusing on

one segment, such as SCM and those like Oracle, who offered a complete package of software

targeting all segments. Oracle was one of the first to employ the latter approach, which

eventually beat out the specialized vendors. Yet, Oracle’s E-Business Suite, along with the

package offered by PeopleSoft, proved to be slightly overpriced. The customer’s preference for

lower cost solutions is reflected in the decline, from 9.1% in 2000 to 7.0% in 2002 of Oracle’s

share in the ERP market, the largest software application segment by revenue. SAP

experienced a more significant drop from 31.7% to 25.1%. This market share is primarily being

lost to smaller, lower cost firms.

Due to the larger number of firms in the software applications industry, internal rivalry is more

intense than the competition in the database market. Unlike its advantage in database

technology, Oracle’s software applications do not offer the low price and high functionality of its

10g and RAC architecture, and were thus poorly positioned to adapt to the decrease in IT


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spending. However, the large sizes of Oracle and SAP, have served to more than compensate

for the market share losses due to the competitive shortcomings of their products.

Both SAP and Oracle have actually increased market share through the acquisition of

competition. Oracle, in particular, has substantially increased its market share through the

acquisition of PeopleSoft, who had recently acquired J.D. Edwards. In 2002, the combined

market share of the ERP segment for these three firms was 16.2%, compared to the 25.1%

share of SAP. Current market share estimates should be available once the integration of

PeopleSoft into Oracle is complete. Gaining market share through acquisition is a particularly

attractive and likely strategy for Oracle, given its high net profit margin. Whether Oracle can

apply the efficiency with which it runs its business to those it acquires remains to be seen; if it

can, Oracle may be able to acquire significant market power, particularly in the ERP segment.

Buyer and Supplier Power

In both industries, inputs come predominantly in the form of Research and Development

expenses. Thus, supplier power is not a primary concern. Furthermore, the global nature of the

markets for database technology and software applications means that there is no single large

buyer, like Wal-Mart, who is able to dramatically influence Oracle’s operations.

Substitutes and Complements

Due to the complex nature of both database technologies and software applications, there do

not appear to be any financially viable substitutes for either of these types of product. Clearly,

within each of these industries, competition amongst vendors provides the only real threat of

product substitution.

The downturn in IT spending that has occurred over the last couple of years is a strong

complement to Oracle’s product direction, particularly in the database technologies market.

Tighter budgets have made customers more cost conscious, which has fueled the adoption of

the lower cost Linux-based servers, an operating system on which Oracle’s 10g and RAC

perform especially well. Given the overall higher performance and lower cost of Oracle’s newest

product offering relative to its competitors, the continuation of current trends should work to

increase the attractiveness and adoption of Oracle’s database offering.


SageGroup, LLP 23

The complementary nature of tighter IT budgets is also true for the software applications

industry. However, Oracle does not uniquely benefit from this trend as it does in the database

market. Both, SAP and Oracle have managed to whether the downturn in spending particularly

well compared to their more specialized competitors due to the overall functionality and broad

range of their offering. The position of SAP and Oracle is further strengthened by their size, and

in the case of Oracle, the revenues it receives from its database business. Less susceptible to

decreases in IT spending than other smaller, more specialized firms, Oracle and SAP should

benefit from the persistence of lower IT expenditures.

Entry

The relational database market is divided between Oracle (27%), IBM (37%), and Microsoft

(18.5%). Since the 1990’s, these three vendors have managed to dominate the market through

acquisition (in 2001 IBM purchased Informix, the fourth-largest DBMS vendor with a 3% share),

large R&D expenditures, and a combination of aggressive marketing and strategic alliances.

Smaller firms simply can’t achieve the massive economies of scale required to justify both the

large financial commitment to R&D and the sales force necessary to compete in the global

market. Furthermore, the maturation of the industry has also resulted in increased competition

amongst IBM, Oracle, and Microsoft. This has further lowered prices and increased the

incentive of these companies to invest more in R&D and complementary technologies; only

exacerbating the already high barriers to entry.

However, effective means to combat these high barriers to entry do exist in the open source

movement. The increasing adoption of the Linux operating system has been the most obvious

example of open source success. The growing popularity of open source databases, MySQL in

particular, may pose a long term threat to Oracle. While they are soundly outclassed by the

major firms offerings in terms of scalability, reliability, manageability, and performance, open

source databases are making inroads at the lower end of the market. While they do not pose a

significant threat due to lack of enterprise support, they could increase pricing pressure at this

end of the market. Furthermore, following the example of Linux, increased improvements to

open source databases over time may make them a more attractive option to cost conscious IT

administrators.

Similar to the database technology market, growth opportunities have become limited in the

market for software applications. Before its acquisition of PeopleSoft, SAP, PeopleSoft, and


SageGroup, LLP 24

Oracle controlled about 62% of the ERP market (the largest segment of software applications),

whereas in 2000 these same vendors accounted for about 56% of the market. These results are

consistent with the other areas of the software applications industry (CRM and SCM) where the

leading applications vendors SAP and Oracle have been aggressively consolidating. Like the

DBMS industry, the economies of scale enjoyed by both SAP and Oracle, coupled with their

product recognition and the slowdown in IT spending, have created a significant barrier to entry

for smaller, higher cost firms. For those that already exist in the industry, these factors have

rendered many into potential targets for acquisition.


SageGroup, LLP 25

PeopleSoft

The strategic acquisition of PeopleSoft has had a significant impact on Oracle’s business. The

company's main business is selling database software, however market maturation has

increased the need for major firms to leverage themselves by offering integrated packages of

software. For Oracle, PeopleSoft was an attractive target because of its large customer base,

operational inefficiencies, and because it would give Oracle the necessary size to more

effectively compete against the market leader SAP. However, Oracle’s hostile bid to acquire

PeopleSoft was a long, bitter, and very public battle, marked by the Department of Justice’s

antitrust case against Oracle and its subsequent dismissal. While the acquisition of PeopleSoft

offers a number of potential upsides to Oracle’s businesses, these benefits are contingent upon

the successful integration of the two companies.

Almost all of the application vendors have their revenues evenly divided between new license

revenues, maintenance, and service. It is clear that having a large installed base is crucial,

which explains Oracle’s extra commitment to retain their acquired clients through the

development and support of PeopleSoft’s and J.D. Edwards’s products over the next ten years.

In the short term, these added expenditures will probably make it more difficult for Oracle to

recover what it paid for PeopleSoft. However, the increased revenues generated from this larger

customer base should enable Oracle to invest more in applications development and support.

Furthermore, Oracle is picking up a huge base of customers (around 12,000) to which it can sell

an integrated package of databases, applications, and software. Finally Oracle should be able

to increase margins through the elimination of PeopleSoft‘s operational inefficiencies.

However, there are a number of factors that have hindered the realization of these benefits. The

hostility and length of the acquisition appears to have decreased consumer confidence in both

Oracle and PeopleSoft applications. The amount of energy expended by both companies

throughout the takeover process, led many to question both Oracle and PeopleSoft’s ability to

adequately support their products. By the end of 2004, the combined market shares of Oracle

and PeopleSoft decreased to 23%, down from 29% two years earlier.

While Oracle was preoccupied with the acquisition of PeopleSoft, SAP definitely went on the

offensive. SAP has taken advantage of the uncertainty surrounding the acquisition by tempting

PeopleSoft customers with a “Safe Passage” in the form of a 75% discount for switching to their

software. SAP has also purchased a company based in Texas that provides third party support

for PeopleSoft applications. Oracle will be required to spend a lot of energy integrating


SageGroup, LLP 26

PeopleSoft, as well as the recently acquired Retek. Oracle’s next generation software, Project

Fusion, is not expected to be finished until 2008. Meanwhile, SAP is remodeling its applications

and a software program called NetWeaver, which will let customers better customize SAP’s

products. SAP is hiring 1,000 engineers in an effort to finish the project in 2007.

Since service and maintenance expenses make up a large part of the total cost of an

application’s adoption, it is crucial that Oracle maintain these services. This will not be easy.

Given the size of the integration, it will be difficult to efficiently meld staffs, product lines and

customer bases. Software is a remarkably complex product that requires immense amounts of

engineering and adroit salesmanship. We feel that it is imperative for Oracle to increase

expenditures on application development and support in order to assuage client’s fears, to raise

the quality of their product, and to efficiently incorporate PeopleSoft’s technological advantages

into its next generation software.

Implications of the Federal Court’s Ruling

The Justice Department opposed the proposed merger, claiming that it would result in higher

prices, less innovation and fewer choices for businesses and other purchasers of large software

systems. But while trying to prove that there were only three software firms big enough to

compete for the largest contracts, it was impossible to discount the number of other firms

fighting or capable of fighting for a share of the market. This point was adequately addressed by

the Department of Justice itself, whose large contract with American Management Systems, a

mid-size firm that outbid Oracle, illustrated the flaws in the government's case.

The Federal ruling in favor of Oracle may have a significant impact on the competitive

landscape. The increased incentive of large firms to leverage their various products by offering

integrated packages of databases, applications, and software, has encouraged the formation of

strategic relationships between firms in related markets. The government's difficulty in proving

anti-competitive practices among software manufacturers may possibly encourage Oracle’s

competitors to purse a more aggressive strategy of acquisition, allowing them to more

effectively leverage their product offerings. In particular, there is the potential danger of a deal

between Microsoft and SAP, whose secret merger talks were brought to light in Oracle’s

antitrust case. This would enable SAP to take advantage of Microsoft’s large customer base of

small to medium sized clients. Microsoft would in turn, be able to leverage SAP’s enterprise

expertise to promote its products. These talks were initially abandoned by Microsoft due to fears


SageGroup, LLP 27

that they would only exacerbate their current antitrust issues. However, given the Federal

Court’s ruling, we feel that such a merger may pose a threat.


SageGroup, LLP 28

Strategic Outlook

Currently, large vendors such as Oracle, are trying to differentiate themselves by offering

expanding lists of integrated complementary technologies. However, the beneficial effect of

complementary products depends on the quality of the various offerings. Oracle’s target

markets are increasingly competitive and Oracle simply cannot afford another rushed product

release plagued by bugs and lacking promised features, particularly in the applications market.

Oracle currently has a technological advantage over its peers in the core database market. The

preservation of this advantage and the necessary improvement of its applications offering will

require an increase in R&D expenditures.

Oracle must also integrate PeopleSoft and Retek as smoothly as possible. While Retek, given

its smaller size, should not pose much of a problem, the complexity of the PeopleSoft

integration merits increased attention. Given the large premium Oracle paid for the company,

and the other associated costs surrounding the acquisition, Oracle needs to retain as much of

PeopleSoft’s consumer base as possible. To achieve this goal, increasing consumer

reassurance programs and enhanced support are necessary and merit the associated increase

in SG&A expenditures.

In its purchase of Retek, Oracle is increasing and further diversifying its applications offering.

While we feel that it is important for Oracle to pursue the acquisition of complementary

technologies, we believe that Oracle can significantly differentiate itself from its competitors

through the pursuit of implementation and development technologies. The complexity of current

software technology and the average client’s large size makes the installation and deployment

process an inherently costly one for customers. We feel that Oracle should pursue the

development and the acquisition of technologies that will allow customers to significantly

decrease the amount of time spent installing and deploying Oracle software. This should result

in significant cost savings for the customer, and should give Oracle’s products a competitive

advantage.

Given its strong financial position, Oracle is in a unique position to capitalize on current market

trends. Despite low market growth rates, we expect Oracle to continue to garner market share in

the relational database and application server markets. However, we believe that Oracle can

further increase its revenues and expenditures in the areas mentioned above without sacrificing


SageGroup, LLP 29

margins. We see this being primarily accomplished through strategic acquisitions and through

the continued increase in offshore personnel.

Continued Offshoring of Workforce The continued transition of its workforce to both India and China should help to improve

margins, but should also improve Oracle’s ability to successfully rationalize acquired firms.

While the gains of such offshoring may be masked in the short run by the weak dollar, we

expect to see increased benefits as the dollar stabilizes and improves.

Strategic Acquisitions It would be most beneficial for Oracle to pursue strategic acquisitions in markets complementary

to their database and applications business as well as acquisitions in adjacent markets that are

related to Oracle’s area of expertise; data management. Given the efficiency of Oracle’s current

business practices, we feel Oracle should target smaller, less efficient companies. Acquiring

another large company like PeopleSoft would be a mistake, as its integration and rationalization

would most likely be a long and costly process. It will be significantly easier for Oracle to

incorporate and minimize the operational inefficiencies of a smaller firm. Furthermore, the

acquisition of such firms would diversify and bolster Oracle’s current technologies, which will

more effectively leverage the adoption of its database systems, the corporation’s primary source

of revenues. Currently, we have identified three firms that are, or may soon be, attractive

targets for acquisition.

Altiris Inc. Altiris Inc., with an EVS of 3.1x and margins below the industry standard, would be a potential

target. The company provides IT asset management software that helps organizations manage

their technology systems. Altiris' client, server, and asset management software handles IT

deployment and migration, server provisioning and management, inventory and asset

management, performance tracking, and help desk and problem resolution.

Large scale implementation of Oracle software across servers tends to be a costly, time

consuming manual task. While Oracle 10g contains management tools designed to facilitate its

integration, these tools only function on systems that have been preconfigured to run on

Oracle’s software. This makes it easier for current clients to upgrade to Oracle 10g, but does

little to mitigate the transition costs potential clients would incur from a long installation period.


SageGroup, LLP 30

Clients usually deal with this problem with the help of Oracle’s consulting branch or through the

use of third party software, which has become more popular given low IT spending.

We feel that the acquisition and rationalization of Altiris would benefit Oracle in a number of

ways. Not only would it help boost margins but it may also help to leverage the adoption of both

Oracle 10g and Project Fusion, among other products, by reducing the associated costs of

installation and deployment. Altiris’s technology may also bolster Oracle’s consulting business,

which has been declining due to the cost conscious nature of clients. Furthermore, Altiris’s

technology would also help Oracle retain PeopleSoft’s consumer base by reducing the cost of

the eventual transition to Oracle’s own applications. Finally, as more of its database clients

migrate from UNIX to Linux, Oracle runs the risk of losing customers to IBM’s DB2. Given the

advantages of the Oracle 10g over DB2, Altiris’s technology would only reinforce the

attractiveness of Oracle’s offering, which would allow Oracle to expand its market share.

FileNet Enterprise content management is one such adjacent market that Oracle may be well suited to

enter. FileNet is becoming an increasingly attractive option with an EVS of 2.2x and low

margins. The company is a leading provider of data and content management software and

optical storage systems for managing and sharing information across corporate networks and

the Internet. After a significant increase in its market capitalization due to the acquisition of

Documentum by EMC, FileNet’s value is starting to decline. We feel that the addition of FileNet

would complement Oracle’s current offering and the company’s operational inefficiencies would

allow Oracle to increase its margins.

BEA Systems BEA Systems, who competes against Oracle and IBM, in the application server market is also

becoming an increasingly attractive target. The company is a leading provider of application

server software used by software developers to establish platforms (which span mainframe,

client-server, and Web-based environments) upon which software applications run. Its products

enable companies to create and deploy platforms that support functions such as transaction

processing, billing, customer service, provisioning, and securities trading.

Oracle has recently made significant inroads against its two main competitors in the $2.3 billion

a year application server market. Their recent success can be attributed to the marketing

strategy of bundling complementary software into their database offering. Oracle’s market share


SageGroup, LLP 31

gains have come particularly at the expense of BEA Systems, whose software is run primarily

on Oracle databases. Over the last year, the value of BEA Systems has been on the decline,

dropping 25%. Furthermore, BEA System’s net profit margin (12.14%) is less than half of

Oracle’s (25.95%). If the value of this company continues to decrease, acquisition and

rationalization would be particularly attractive. This is further encouraged by the fact that many

of BEA System’s clients currently run Oracle software, allowing for a potentially smoother

transition of customers to Oracle products. However, we feel that given the size of BEA

Systems, and Oracle’s current preoccupation and difficulties associated with the integration of

PeopleSoft, the company may be more of a long term target.


SageGroup, LLP 32

Conclusion Oracle is in a strong position relative to its competitors. Its solid balance sheet and the efficiency

of its businesses should allow it to continue to pursue strategic acquisitions. However, we feel

that this strategy can be further tailored to give Oracle’s products a competitive advantage. This

advantage will come through increased investments in research and development and SG&A.

Oracle can maximize these investments if it concurrently pursues strategic acquisitions in IT

asset management software. We feel that the acquisition of Altiris should take priority over

potential options in adjacent markets. By prudently investing in strategic acquisitions, acquiring

new technologies, and increasing investments in R&D and SG&A, Oracle should continue to

strengthen its hold over the database market and improve its strategic position against SAP.

Overall, we believe that this strategy will increase revenues without sacrificing margins and

should make Oracle an increasingly dominant global player.


SageGroup, LLP 33

Appendix Discounted Cash Flow Analysis

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Perpetuity

REVENUES

Total Software License Revenues $3,541 $3,914 $4,142 $4,356 $4,582 $4,757 $4,939 $5,087 $5,240 $5,397 $5,559 $5,726

Total Service Revenues $6,615 $6,970 $7,367 $7,809 $8,277 $8,526 $8,781 $9,045 $9,316 $9,596 $9,883 $10,180

Total Revenues $10,156 $10,884 $11,509 $12,165 $12,859 $13,283 $13,720 $14,132 $14,556 $14,993 $15,442 $15,906

OPERATING EXPENSES Total Operating Expenses and Cost of Revenue $6,292 $6,544 $6,805 $7,010 $7,220 $7,436 $7,660 $7,889 $8,126 $8,370 $8,621 $8,880

Operating Income $3,864 $4,341 $4,703 $5,155 $5,639 $5,846 $6,061 $6,243 $6,430 $6,623 $6,822 $7,026

EBIT $3,945 $4,422 $4,784 $5,236 $5,720 $5,927 $6,142 $6,324 $6,511 $6,704 $6,903 $7,107

FREE CASH FLOW $2,897 $3,222 $3,603 $3,994 $4,355 $4,513 $4,676 $4,816 $4,961 $5,111 $5,265 $5,423 $94,003

$1 $2 $3 $4 $5 $6 $7 $8 $9 $10 $11

Present Value of FCF $2,805 $2,748 $2,684 $2,594 $2,397 $2,228 $2,072 $1,938 $1,824 $1,680 $1,544 $36,242

Sum of FCF $60,756.67

+ Market Value of Cash $9,932.00

- Market Value of Debt $171.00

Market Value of Equity $70,859.67

Number of Shares Oustanding 5220

Price Per Share $13.57

Price as of 3-9-05 $13.55

Market Capitalization $70,731.00

DCF Assumptions

Beta 1.454 1.404 1.354 1.304 1.254 1.204 1.154 1.104 1.054 1.004 1 1

Tax Rate 0.308 30.80% 30.80% 30.80% 30.80% 30.80% 30.80% 30.80% 30.80% 30.80% 30.80% 30.80%

Discount Rate (WACC) 13.22% 13.22% 13.22% 13.22% 13.22% 13.22% 13.22% 13.22% 13.22% 13.22% 13.22% 13.22%

Database License Growth Rate 0.12 0.06 0.05 0.05 0.04 0.04 0.03 0.03 0.03 0.03 0.03 0.03

Applications Software License Growth Rate 0.04 0.05 0.06 0.06 0.03 0.03 0.03 0.03 0.03 0.03 0.03 0.03

License Updates and Support Growth Rate 0.06 0.06 0.06 0.06 0.03 0.03 0.03 0.03 0.03 0.03 0.03 0.03

Operating Expense Growth Rate 0.04 0.04 0.04 0.03 0.03 0.03 0.03 0.03 0.03 0.03 0.03 0.03

Depreciation and Amortization Growth rate -0.08 -0.08 0.03 0.04 0.04 0.04 0.04 0.04 0.04 0.04 0.04 0.04

Capital Expenditures Growth Rate -0.44 -0.5 0.4 0.5 0.1 0.03 0.03 0.03 0.03 0.03 0.03 0.03

Change in Working Capital -0.28 -0.5 -0.9 -0.9 -0.9 -0.9 -0.9 -0.9 -0.9 -0.9 -0.9 -0.9

Long Term Discount Rate 0.1

Terminal Growth Rate 0.04

WACC Assumptions

Rate on 10 Year T-Bill 5.3% Return on Equity (Industry) 12.1% Debt ( in millions $) 171 Equity ( in millions $) 8550 Debt / Equity 0.02 Tax Rate 30.8%

WACC 13.22%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

ROR ( E(Ri)) = Rf + Bi ( E(Rm) - Rf ) 15.19% 14.85% 14.51% 14.17% 13.83% 13.49% 13.15% 12.81% 12.47% 12.13% 12.10% 12.10%

DuPontT Analysis

Net Profit Margin 26.40% Total Asset Turnover 0.8 Total Assets 12,763 Total Equity 7,995 Equity Mulitplier 1.60 ROE 33.72%


SageGroup, LLP 34

References Besanko, David, et al. Economics of Strategy. Indianapolis: Wiley, Cole, August 2003. Business and Company Resource Center (http://libraries.claremont.edu/research/databases/dbredirect/BusCompResCtr.html) Flinders, Karl. “Oracle and PeopleSoft saga ends in purchase”. MicroScope, Jan 10, 2005. p.1 Hamm, Steve. “Larry, You Picked A Nasty Fight.” Business Week Apr 4, 2005. p. 42

Hoovers (www.hoovers.com)

“Oracle Corporation.” Bear Sterns Analyst Report, 3/2/04. “Oracle Corporation.” Goldman Sachs Analyst Report, 10/23/04. “Oracle Corporation.” Bank of America Initiation Report, 3/2/03. Oracle Corporation 10-K Filing, 2004 Schwartz, Ephraim. “Where Do We Go From Here?” InfoWorld; Jan 3, 2005. p. 10 Shuit, Douglas. “Why Oracle won a round in court.” Workforce Management. Oct 2004. p. 26 Yahoo Finance (http://finance.yahoo.com/)

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