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RISK FACTORS AND RISK MANAGEMENT
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Internal risk management policies and procedures
SAP has a system in place comprising multiple mechanisms
across the SAP Group to recognize and analyze risks early and
respond appropriately. These mechanisms include recording,
monitoring, and controlling internal enterprise processes and
business risks using internal reporting functions, a number of
management and controlling systems, and a planning process
that is uniform throughout the Group. SAP has created
standard documentation of key business processes of SAP AG
and all of its major subsidiaries. These standard processes are
periodically assessed and tested by dedicated “process champions”
as well as SAP’s global internal audit service as to their
design and operating effectiveness. This is to mitigate typical
risks inherent in such processes in line with the requirements
of applicable legal requirements. Further elements of the
system include a corporate Code of Business Conduct for
employees, which was formalized in 2003, and the work of the
Supervisory Board in monitoring and controlling the Executive
Board. In early 2003, SAP created a central dedicated
corporate risk management office along with a global network
of risk management practitioners tasked to consolidate and
enhance SAP’s various existing risk management activities in
accordance with a uniform corporate methodology. Pursuant
to SAP’s enterprise risk management program, various regular
business activities – from software development programs,
customer implementation projects, and internal IT system
implementations to a variety of corporate areas – are continuously
assessed against a range of predefined generic risk categories
identified in a uniform corporate risk catalog. Key risk
factors identified and tracked using the enterprise risk management
program are summarized below in the same risk
category structure as established by SAP’s internal risk management
reporting system.
Economic risks
- Implementation of SAP software products can constitute a
major portion of the customers’ overall corporate budget.
Customers’ willingness to invest in acquiring and implementing
SAP products and the timing of customers’ investment
tend to be negatively affected in a prolonged economic
or financial crisis. A slow or weak economic recovery or
other difficulties in the economies where the Company
licenses products, including Europe, the Americas, and Asia,
could thus have an adverse effect on SAP’s business, financial
position, operating results, and cash flows.
- The financial, political, economic, and other uncertainties
following terrorist attacks like those in the United States and
Spain, and other acts of violence or war such as the conflict
in Iraq, could damage the world economy and affect SAP’s
and its customers’ investment decisions over an extended
period of time.
- SAP’s products and services are currently marketed in over
120 countries worldwide. Sales in these countries are subject
to risks inherent in international business activities, including,
in particular, general economic or political conditions
in each country, overlap of differing tax structures, and regulatory
constraints such as import and export restrictions,
regulations of the Internet, as well as additional requirements
for the design and distribution of software or services.
Market risks
- The entire IT sector, including the software industry, is
currently experiencing consolidation through mergers and
acquisitions, particularly involving larger companies, most
notably the recently announced acquisition of PeopleSoft,
Inc. by Oracle Corp. Large companies like IBM and Microsoft
continue to expand into market areas targeted by SAP and
thus increasingly compete with SAP. This could have a
material adverse effect on SAP in a variety of ways, such as
delaying sales due to customer uncertainty and subjecting
SAP to competition from stronger, established companies
or new peer group companies.
- Competitors have established or may establish cooperative
relationships among themselves or with third parties to
address their products to customer needs. In addition, SAP
believes that competition will increase as a result of consolidations
among potential customers of SAP’s products as well
as among its competitors. It is possible that new alliances
among competitors may emerge and acquire segment shares
to SAP’s disadvantage.
- The recent trend toward business process outsourcing
BPO could result in increased competition for SAP through
the entry of systems integrators, consulting firms, telecommunications
companies, computer hardware vendors, and
other IT service providers. SAP may be unable to demonstrate
the value of SAP solutions to customers and to offer an
attractive business model. The perception of value created by
SAP’s products among end customers could be diminished
to the extent outsourcing providers bundle SAP applications
with their services. While most of SAP’s revenue is currently
derived from licence contracts directly with end customers,
an increased trend to outsourcing business processes to
external providers could have an adverse impact on SAP’s
revenue, earnings, and results of operations. In addition,
the distribution of applications through application service
providers may reduce the price paid for SAP products or
adversely affect other sales of SAP products.
- SAP’s large installed customer base has traditionally generated
a large portion of SAP’s revenue. If SAP’s customers decide
not to renew their maintenance agreements or license
additional products or contract for additional services, or if
they reduce the scope of their maintenance agreements,
SAP’s revenue could significantly decrease and the operating
results could be adversely affected.
Strategic planning risks
- SAP has entered into agreements with a number of leading
computer software and hardware suppliers and technology
providers to cooperate and ensure that certain of the products
produced by such suppliers are compatible with SAP
software products. SAP has also supplemented its consulting
and services through alliance partnerships with third-party
hardware and software suppliers, systems integrators, and
consulting firms. Most of these agreements and alliances are
of relatively short duration and non-exclusive. In addition,
SAP has established relationships relating to the resale of
certain of its software products by third parties. There can be
no assurance that these third parties or business partners,
most of whom have similar arrangements with SAP’s competitors
and some of whom also are in competition with SAP,
will continue to cooperate with SAP when such agreements
or partnerships expire or require renewal. In addition,
despite corresponding certification measures taken by SAP,
there can be no assurance that such third parties or partners
will provide high-quality products or services. This could
adversely affect the demand for SAP’s software products.
Human capital risks
- SAP’s operations could be adversely affected if senior managers
or other skilled personnel were to leave and qualified
replacements were not available. Especially as SAP embarks
on the introduction of new and innovative technology offerings
to its customer base, such as the SAP NetWeaver platform,
SAP is relying on being able to build up and maintain a
specialized workforce with deep technological know-how.
Most of SAP’s current employees are subject to employment
agreements or conditions that (i) do not contain post
employment noncompete provisions and (ii) in the case of
most of the existing employees outside of Germany, permit
the employees to terminate their employment on relatively
short notice. SAP’s continued attractiveness as an employer
has been confirmed in a variety of conducted surveys. Nevertheless,
in the ongoing economic recovery the competition
for highly qualified talents in the IT industry is again gradually
increasing, and there can be no assurance that SAP will
continue to be able to attract and retain its key personnel.
- SAP has a history of rapid growth and will need to effectively
manage future growth to be successful in meeting its profitability
targets. To support SAP’s future growth, SAP expects
to continue in the long term to increase headcount in lower
cost countries such as India or China. However, there can
be no assurance that SAP’s profitability will increase as the
Company expands its business, especially to the extent SAP
cannot sufficiently staff additional headcount in lower cost
countries due, for example, to a local increase in competition
for workforce.
Organizational and governance-related risks
- SAP AG as a stock corporation domiciled in Germany and
listed in the United States is subject to governance-related
regulatory requirements under both jurisdictions that are
among the highest standards worldwide and have considerably
grown in the past few years. SAP is fully supportive of
the intentions of these laws and standards and believes it has
initiated thorough and detailed implementation measures to
fully comply with all relevant requirements. However great
SAP’s efforts, there can be no assurance that the Company
will not be held in breach of the complex and highly specific
regulatory requirements, for example where individual
employees behave fraudulently or negligently. Any such
accusation against SAP, whether merited or not, may have a
material adverse impact on SAP’s reputation.
Communication and information risks
- SAP has established a range of security standards to help
ensure that internal, confidential communications and
information about sensitive subjects such as future strategies,
technologies, and products are not improperly or prematurely
disclosed to the public. However, there is no guarantee
that the established protective mechanisms will work in
every case. SAP’s competitive position could be considerably
compromised if, for example, confidential information
about the future direction of its product development
became public knowledge.
Financial risks
- SAP’s revenue in general, and in particular SAP’s software
revenue, is difficult to forecast for a number of reasons,
including the relatively long sales cycles for SAP products,
the timing of the introduction of new products or product
enhancements by SAP or its competitors, the potential
for delay of customer implementations of SAP software
products, changes in customer budgets, seasonality of a customer’s
technology purchases, and other general economic
and market conditions. Because a high percentage of SAP’s
expenses are relatively fixed in the near term, any shortfall in
anticipated revenue could result in significant variations in
SAP’s results of operations from quarter to quarter.
- Although the euro has been SAP’s financial and reporting
currency since January 1, 1999, a significant portion of SAP’s
business is conducted in currencies other than the euro.
As a consequence, period-to-period changes in the average
exchange rate of a particular currency can significantly affect
reported revenue and operating results. In general, appreciation
of the euro relative to another currency has a negative
effect on reported results of operations, while depreciation
of the euro has a positive effect. SAP continually monitors
the exposure to currency risk and pursues a companywide
foreign exchange risk management policy. SAP has in the
past hedged, and expects in the future to hedge, such risks at
least partly with certain financial instruments. However,
there can be no assurance that SAP’s hedging activities, if
any, will be effective.
- Variances or slowdowns in SAP’s licensing activity may
negatively impact current and future revenue from services
and maintenance, since such services and maintenance
revenue typically lag behind license revenue. Any decrease in
the percentage of SAP’s total revenue derived from software
licensing could thus have an adverse effect on its business,
financial position, and results of operations or cash flows.
- SAP enters into derivative instruments to hedge the anticipated
cash flows in connection with SAP’s employee stock
appreciation rights (STAR) plan. There can, however, be no
assurance that the benefits achieved from hedging the STAR
plan exceed the related costs.
Project risks
- Implementation of SAP software is a process that often
involves a significant commitment of resources by its
customers and is subject to a number of significant risks over
which it has little or no control. SAP cannot provide assurances
that protracted installation times will not continue,
that shortages of trained consultants will not occur, or that
the costs of installation projects will not exceed the fixed
fees being charged by SAP. Any such events could result in
customer claims and harm SAP’s image.
Product risks
- To achieve customer acceptance, new products and product
enhancements can require long development and testing
periods, which may result in delays in scheduled introduction.
Generally, first releases are licensed after a detailed
internal validation process. New products and product
enhancements may nevertheless contain a number of undetected
errors when they are first released. As a result, in
the first year following the introduction of new software
releases, SAP generally devotes significant resources working
with early customers to correct such errors. There can be
no assurance, however, that all such errors can be corrected
to the customer’s satisfaction, with the result that certain
customers may bring claims for cash refunds, damages,
replacement software, or other concessions. The risks of
errors and their adverse consequences may increase as SAP
seeks simultaneously to introduce a variety of new software
products. Any such event could have a material adverse
effect on SAP’s financial condition, results of operations,
cash flows, and reputation.
- The use of SAP software products by customers in businesscritical
applications and processes and the increased complexity
of SAP software raise the risk that customers or third
parties may pursue warranty, performance, or other claims
against SAP in the event of actual or alleged failures of SAP
software products, or the provision of services.
- In addition, SAP products include security features that are
intended to protect the privacy and integrity of customer
data. Despite these security features, these products may
be vulnerable to break-ins and similar problems caused by
Internet users, such as hackers bypassing firewalls and misappropriating
confidential information. Such break-ins
or other disruptions could jeopardize the security of information
stored in and transmitted through the computer
systems of SAP customers and lead to damages claims by
customers against SAP.
- Although SAP’s agreements generally contain provisions
designed to limit SAP’s exposure as a result of actual or
alleged failures of SAP software products, the provision of
services or application hosting, or security features, such
provisions may not cover every eventuality or be effective
under applicable law. Any claim, regardless of its merits,
could entail substantial expense. The accompanying publicity
of any claim, regardless of its merits, could adversely
affect the demand for SAP software.
- SAP licenses numerous third-party technologies that are
incorporated into its existing products. There can be no
assurance that the licenses for certain third-party technologies
will not be terminated against SAP’s interests or that
SAP will be able to license third-party software for future
products. This could lead to short-term substitution challenges
and to higher development expenses.
- In 2003, SAP announced the introduction of SAP NetWeaver,
the Company’s new, Web-based technology and application
platform. A key component of SAP’s strategy for a broad
adoption of SAP NetWeaver is offering the platform to certified
third-party independent software vendors (ISVs) as a
basis for those vendors to develop and offer their own business
applications. To the extent that SAP cannot attract a
sufficient number of capable ISVs delivering high-quality
solutions based on the platform, the desired market penetration
of SAP NetWeaver may not be achieved. Any ISV-developed
solutions with significant errors may reflect back
negatively on SAP’s reputation and thus indirectly impede
SAP’s own business operations. Further, as with the introduction
of any new product, there may be errors in the SAP
NetWeaver component technology itself that might require
the devotion of a substantial amount of resources to correct.
In addition, as with any open platform design, the greater
flexibility provided to customers to use data generated by
non-SAP software may reduce customer demand to select
and use certain SAP software products.
Other operational risks
- SAP relies on a combination of the protections provided by
applicable trade secret, copyright, patent and trademark
laws, license and non-disclosure agreements, and technical
measures to establish and protect its rights in SAP products.
Despite these efforts, there can be no assurance that these
protections will be sufficient. For example, the laws of
certain countries do not protect SAP’s proprietary rights to
the same extent as do the laws of the United States or
Germany.
- Although SAP has been issued patents under its patent
program and has a number of patent applications pending
for inventions claimed, there can be no assurance that, in the
future, patents of third parties will not preclude SAP from
utilizing certain technologies in its products or require SAP
to enter into royalty and licensing arrangements on terms
that are not favorable to SAP. Although SAP does not believe
that it is infringing any proprietary rights of others, third
parties have claimed and may claim in the future that it has
infringed their intellectual property rights. SAP expects that
its software products will increasingly be subject to such
claims as the number of products in its industry segment
grows, as SAP expands its products into new industry segments,
and as the functionality of products overlap. In addition,
SAP is selectively embedding certain third-party opensource
software components in SAP software solutions.
SAP has implemented strict and detailed approval processes
around the deployment of such components, which involve
among other topics a thorough check of any corresponding
license terms. Nevertheless, there can be no assurance that,
in the future, a third party will not assert that SAP products
or SAP’s deployment of third-party, including open-source,
software violate its patents, copyrights, or trade secrets. Any
claims, with or without merit, could be time-consuming,
result in costly litigation, cause product shipment delays,
subject SAP products to an injunction, require a complete or
partial redesign of the relevant product, or require SAP to
enter into royalty or licensing agreements. Royalty or licensing
agreements, if required, may not be available on terms
acceptable to SAP or at all.
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SAP relies on encryption, authentication technology, and
firewalls to provide security for confidential information
transmitted to and from SAP on the Internet. Anyone who
circumvents these security measures could misappropriate
proprietary information or cause interruptions in the
Company’s operations. Computer viruses could be introduced
into SAP’s systems or those of SAP’s customers or
suppliers, which could disrupt SAP’s network or make it
inaccessible to customers or suppliers. SAP’s security measures
may be inadequate to prevent security breaches, and the
Company’s business would be harmed if it does not prevent
them. In addition, SAP may be required to expend significant
capital and other resources to protect against the threat
of security breaches and to alleviate problems caused by
breaches as well as by any unplanned unavailability of SAP’s
internal IT systems in general for other reasons.
- To complement or expand its business, SAP has made and
expects to continue to make acquisitions of additional
businesses. SAP’s current strategy for growth includes acquisitions
of small and midsize businesses. Risks commonly
encountered in such transactions include the inability to
successfully integrate the acquired business and the acquired
technologies or products with SAP’s current products and
technologies; a potential disruption of SAP’s ongoing business;
the inability to retain key technical and managerial
personnel; the assumption of material unknown liabilities
of acquired companies; the incurrence of debt or significant
cash expenditure; a potential adverse impact on SAP’s relationships
with partner companies, third-party providers of
technology or products, or customers; and regulatory
constraints. SAP may not be able to effectively counter these
risks, which could reduce the envisaged business benefit of
certain acquisitions.
- SAP has acquired and expects to continue to acquire equity
interests in technology-related companies, many of which
currently generate net losses and require additional capital
outlay from their investors. It is possible that changes in
market conditions affect the performance of companies in
which SAP holds investments, requiring additional unexpected
capital infusions. Such events could negatively impact
SAP’s results and financial position or its ability to recognize
gains from the sale of marketable equity securities. Additionally,
under German tax laws capital losses or writedowns of
equity securities are not tax-deductible, which may negatively
impact SAP’s effective tax rate.
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SAP maintains extensive insurance against many risks of liability.
The extent of insurance coverage is regularly reviewed
and is modified if SAP finds it necessary. SAP’s insurance
coverage goal is to ensure that, to the extent practicable at
reasonable cost, the financial effects resulting from insurable
events are excluded or limited. Despite these measures,
certain categories of risks are currently not insurable at reasonable
cost. Even where SAP obtains insurance, the coverage
is subject to exclusions that may limit or prevent the
Company’s ability to recover under those policies. Any
failure to obtain or recover under insurance policies could
result in a significant adverse impact on SAP’s financial
position or results of operations.
In SAP’s view, the risks identified above do not threaten SAP’s
existence individually or in the aggregate. SAP is confident that
it can continue in 2005 to successfully counter the challenges
arising from those risks. SAP’s strong position in the market, its
technological leadership, its highly motivated employees, as
well as structured early risk identification processes will be key
factors supporting this goal. |
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