Inside SAP's radical makeoverMarch 29, 2012: 5:00 AM ET
The mission-critical (but unsexy) software giant lost its way with customers. CEOs Bill McDermott and Jim Hagemann Snabe think they can make SAP appealing again.
FORTUNE -- At the stroke of midnight on Feb. 15, a new app called Recalls Plus appeared in Apple's App Store. It promised parents real-time alerts on the latest baby formula or car seat recalls, allowing them to share such information with friends. There was nothing surprising about the app except for three tiny letters at the bottom of its description: SAP.
Indeed, the app is exactly the opposite of what many people expect from SAP (SAP), which specializes in complex back-office corporate software that companies pay millions of dollars to install and maintain. Why would SAP co-CEOs Bill McDermott and Jim Hagemann Snabe green-light a free downloadable product for moms and dads?
The consumer-friendly app, it turns out, is symbolic of bigger changes afoot at the tech giant, based in Walldorf, Germany. Since jointly taking the reins at SAP in February 2010 (more on their unusual power-sharing arrangement in a moment), McDermott, 50, and Snabe, 46, have sped up development cycles, closed a couple of bold acquisitions, and made nice with customers who had lost faith in SAP. Recalls Plus is just one of several signs the company is moving beyond its legacy business and investing in the technologies its customers crave: mobility, cloud, and real-time analytics.
Though SAP enjoys enviable market position -- nearly 80% of the Fortune 500 use SAP software for processes like inventory planning, and 63% of worldwide financial transactions are processed through SAP software at one point or another -- corporations are starting to radically rethink the way they buy and deploy software. Employees are behind the change: They increasingly want to bring their home smartphones and tablets into the workplace, and they expect their office to provide them with the same kinds of apps and online services they enjoy in their personal lives. But instead of embracing online delivery of software, or of computing via the cloud, SAP made a few tepid attempts to develop online versions of its existing products. Meanwhile smaller companies like NetSuite (N), Workday, and Salesforce.com (CRM), which displaced SAP as the world's second-largest provider of customer relationship management software, rushed to fill the void. (The No. 1 CRM vendor is Oracle (ORCL).)
To bolster their software-as-a-service offerings, McDermott and Snabe late last year agreed to spend $3.4 billion to acquire SuccessFactors, a maker of cloud-based human resources software. In a series of interviews with Fortune, McDermott and Snabe acknowledged that the shift to the cloud model has broad financial implications for SAP. The company last year reported $19.8 billion in revenue, 49% of which came from installation fees and long-term maintenance contracts. In a software-as-a-service model, customers usually pay a flat monthly rate for each worker using the app. "Will [SuccessFactors] cannibalize some of our on-premise revenue?" McDermott asks. "Probably, but it's the right thing to do."
The company McDermott and Snabe inherited in 2010 was a mess. Software license sales at SAP in 2009 fell 28%, and revenue declined 8%, to $14.9 billion. "We had lost the trust in relationships with our customers, and employees did not believe in management," says Hasso Plattner, SAP co-founder and chairman of the company's supervisory board. "SAP needed to restore a culture which would allow us to return to innovation and growth." Plattner concluded that the company needed new leadership, and on a Saturday morning in February 2010 he called up McDermott and Snabe to ask if they would jointly take the top job. The following day, a Sunday, the company issued a press release saying CEO Léo Apotheker's contract would not be renewed. (In September 2010, Apotheker was named CEO of HP (HPQ); his tenure lasted less than a year.)
One of McDermott and Snabe's first moves was to acquire Dublin, Calif.-based Sybase for $5.8 billion, a deal that bolstered SAP's offerings for mobile devices. Sybase, which operates as an independent company, is working with SAP to develop tools that allow corporations to build new mobile apps on top of existing SAP software and services. The CEOs also unveiled a new database technology called HANA, which dramatically speeds up calculations by storing data "in memory" rather than on traditional disks. Early sales suggest HANA is a hit, bringing in $221 million in revenue in 2011, when it became available in the second half of the year, and Snabe and McDermott are betting the technology can help SAP achieve their ambitious goal of taking market share from archenemy Oracle, the world's leading provider of database software.
Amid the acquisitions and new-product announcements, McDermott and Snabe hit the road to meet disgruntled customers. They reversed a controversial price hike that SAP instituted during the financial downturn, and pledged to listen to users' concerns. "They immediately began to have an impact on customers," says Rich Adduci, chief information officer of medical-device maker Boston Scientific (BSX).
Customers and employees alike say McDermott, an American, and Snabe, who is Danish, enjoy an easy rapport. Snabe, who runs the product side of the business, brings engineering chops to the CEO job. McDermott, who got his start running a Long Island deli as a teenager and eventually became the youngest division leader at Xerox (XRX), runs SAP's sales and marketing teams. He also happens to have the kind of perfectly coiffed hair usually reserved for actors who play politicians. "Yes, his hair really does always look that good," says Kevin Plank, CEO of apparel maker Under Armour (UA).
Most co-CEO arrangements fail -- BlackBerry maker Research in Motion (RIMM) recently abandoned the two-man structure in favor of a single CEO -- but SAP seems to like the power-sharing model. (Apotheker had a co-CEO at SAP for a time.) It is a bit of a balancing act, but Snabe says he likes having a partner to share the workload. "When problems get too big, you need to divide and conquer," he says.
So far the arrangement seems to be working. Employee morale is up (72% of employees say they're confident about the company's direction, up nine points from 2010), and the stock has climbed almost 40% since McDermott and Snabe took over. But SAP's turnaround is far from complete. Critics say the company still lacks the culture and the talent to keep churning out innovative products and stave off the likes of Salesforce.com, even after acquiring SuccessFactors. "You can get all the nips and tucks and boob jobs you want," says Cowen & Co.'s Peter Goldmacher, "but you'll still be the same inside."
And McDermott and Snabe need to carefully manage the transition from the still-lucrative traditional installed-software business to cloud-based services. Even as many employees clamor for apps and software as a service and pure-play companies grab share, plenty of corporate IT departments want to take a more cautious approach. SAP needs to be able to serve a range of needs while managing changing revenue models. In other words, McDermott and Snabe are engaged in a sort of daily balancing act -- not unlike being co-CEOs.
This story is from the April 9, 2012 issue of Fortune.